(capital expense – 5 minute read)
Hi there accounting fans!
Another question that I hear a lot is the difference between capital and operating expenses. The difference between the two isn’t always clear cut. However, they do have different treatments for tax purposes, so its important to get the classifications correct. Here’s what you need to know:
What’s a capital expense?
A capital expense is a type of business expenditure to acquire or improve a long-term asset, such as property, equipment, or machinery. These expenses are typically large and will benefit the business over a period of time, usually more than one year. Examples of capital expenses include purchasing a new building, renovating a storefront, or buying a new computer system.
A capital expense is capitalised on your balance sheet. This means that it is an asset for your business. It does not show up in your profit and loss statement for the purposes of tax calculation. Instead, you claim a portion of its expense every year via depreciation. You don’t get to claim the entire expense in the year that you purchase it.
What’s an operating expense?
An operating expense is a type of business expenditure that you incur in the day-to-day operations of the business. These expenses are typically smaller and happen on a regular basis. Examples of operating expenses include utilities, rent, salaries, and supplies.
Smaller asset purchases below a certain threshold are operating expenses for tax purposes. As of the tax year this article was written (FY 2023) the threshold for this in Aotearoa is 1,000 NZD (GST exclusive). We call this a minor asset expense.
The differences between capital and operating expense
It’s important to note that the distinction between a capital expense and an operating expense is not always clear-cut. For example, the cost of repairing a piece of equipment may be classified as an operating expense if the repair is minor and does not significantly extend the life of the equipment. However, if the repair is more extensive and significantly extends the life of the equipment, it may be classified as a capital expense.
This is especially true with rental properties. A bathroom renovation is usually a capital expense. But, if the renovation involves repairing the pipes, replacing the faulty shower and re-doing the cracked tiles, it counts as an operating expense. If in doubt, be sure to check with an accountant to make sure you got it right.
Get it right!
Remember, wrongly classifying your expenditures can have tax implications. Don’t get into trouble with the tax authorities. Now that you know the difference between capital expenditure and operating expenditure, you can go back to spending as much as you want on your business growth!
Stay positive!