What Is Capital Addition?
Capital addition is the cost involved for adding new assets or improving existing assets within a business, also called capital expenditures. Capital additions may take the form of adding new parts or features that are expected to increase the useful life of potential of an asset or may involve adding new assets to increase production or capacity. However, repairs made to maintain the usefulness of a piece of equipment or an asset is merely maintenance and not a capital addition—these distinctions are important for capital budgeting and fixed asset accounting.
- Capital additions, also called capital expenditures, are costs involved in buying new assets or improving existing assets.
- These charges are generally recorded on the balance sheet and not the income statement.
- Money spent to maintain or repair an asset would not be a capital addition and instead, be recorded as an expense on the income statement.
- Capital addition can also refer to a capital injection for a bank or an improvement to real estate—which is generally tax-deductible.
- Property insurance capital additions are how the insured value of a home or property will need to be amended if there’s an expansion or renovation of the property.
Understanding Capital Additions
Another way of describing a capital addition is that it is any investment that improves an existing fixed asset or results in the addition of a new fixed asset. As such, a capital addition makes a company or other entity's fixed asset base larger. Any other expenditure would entail a maintenance expense and would be recorded as such.
Types of Capital Additions
Although capital addition is most frequently used in the accounting context as seen above, where it refers to capital investments in long-term assets within a company, it can also mean other things. In banking, capital addition may be used to describe an infusion of capital received by a bank to meet its reserve requirements so it may make additional investments or loans. Capital addition may also be used to describe the cost of improvements by a taxpayer to personal property (particularly real estate). Aspects of such improvements may be deductible, such as replacing a roof. However, repairing a roof is not a capital addition and would be considered a repair.
In property insurance, a capital addition refers to how the insured value of a home or other property will need to be amended if a homeowner expands, extends, or enlarges a property by renovation or with the addition of a feature, such as a larger deck or a swimming pool. Failure to account for a capital addition could lead to a property being underinsured, a shortfall in the replacement value and an insufficient maximum claim amount.
Therefore, the owner should document any property additions and it and report it to their insurer so that a policy may be updated. Most policies will have a capital addition clause that accounts for the possibility of a shortfall in coverage. Such provisions will generally limit coverage on capital additions to 15% of the insured value. They also tend to stipulate that the owner should report any increase in value on a quarterly basis.