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Capital spending involves the process of a company using cash reserves or other liquidated assets to purchase equipment that has a general durable life of more than one year. This often includes buildings, land, heavy machinery, and vehicles. It is a form of business spending that is kept clear on financial ledgers from day-to-day expenses, such as payroll and investment in inventory. As the capital goods deteriorate in value over time, this depreciation is also charted in financial accounting to accurately determine the net asset value of a company through capital depreciation entries.
In business accounting, all capital spending is traditionally listed as a form of investment on the cash flow statement initially. As the equipment deteriorates over the years, its reduced value is considered to be an expense of doing business, and this is recorded on the yearly or quarterly income statement of the company under capital depreciation. This capital depreciation rate is calculated in various ways, and can vary widely from country to country and industry to industry. Depreciation is often based on what the fair market value of a capital asset is at any one time as a component of the entire net worth of the business, or for its utility in serving a productive role in the affairs of the business. Research and development capital spending often falls into a special case arena for depreciation, as such assets usually lend little immediate income value to the firm.
Business liability entries in accounting often include capital spending as it is first an expenditure, not an asset. Not all purchases in terms of capital spending are for direct acquisition of new equipment or land, however. Some expenditures are made to improve upon the quality of already existing capital assets, such as through upgrading them with robotics systems or other improved technologies, or performing extensive maintenance and repairs to extend a capital asset's useful operating life.
The primary motivation around capital spending is that it will increase the bottom line of a business or its level of profit over time. This can occur through increased productivity by labor, an ability to capture more market share through larger volume runs, or to outperform competitors by producing superior products. Capital purchases have the downside in most modern accounting standards that they cannot be deducted as an expense for tax purposes in the first year of their purchase. This is the meaning of the term "capitalized," where capital spending is seen as an investment expenditure in the first year, and an income expense in all succeeding years.
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