You’ve probably heard the term “capital equipment” before, and there’s a reason why. In the U.S., billions of dollars are spent on capital equipment, and spending has increased by over 20% in the last decade.
It is often thought of as assets that help generate income. They’re usually costly and have specific requirements. But what is it and how can you understand the qualifications better?
Keep reading to learn everything you need to know about the basics so you can better understand it!
What Qualifies as Capital Equipment?
Learning about it starts with the definition. A piece of capital equipment can be explained as a good with a functional life of more than a year, which a company uses in its production operations. This equipment is important since it helps a company continue its manufacturing activities.
Companies will often invest to expand their business’s operations. They might also want to keep up with any new technological advances.
Most companies will consider these fixed assets from an accounting point of view. This equipment can only be considered a fixed asset if the company expects it can be used for more than a year and is worth more than $5,000. For new companies, equipment financing might also be available for capital equipment.
Some industries, like aviation, spend more on capital equipment than others. For aviation, most of the business comes from planes. So their investment in capital equipment will be much higher than in other industries.
Manufacturing businesses will also invest more in capital equipment than service industry companies. So any type of delivery system that involves machines, trucks and transportation equipment, etc. will need a lot of investment in capital equipment.
The Definition of Capital Equipment Can Vary by Industry
As mentioned above, different industries have different definitions of capital equipment. This will depend on what they need to use for their business’s operations.
When a company invests in capital equipment, they expect to get operating benefits for years to come, since this also affects a company’s taxes. Most companies will define which items are capital items and establish criteria. The criteria will depend mostly on the policies chosen by the company’s managers and accountants but also depends on local laws.
This may vary, but the criteria generally have three conditions. The first condition is that the asset or equipment must have a minimum functional life or economic life of a year or more. The second condition is that the equipment must have a cost above a certain amount (it could be $1,000 or more). Finally, the equipment must add to the company’s value for business operations.
Thinking about capital equipment in terms of the industry you’re looking at will help paint a clearer picture. Think about the college and education industry. Things like scanning machines, computers, science lab equipment, etc. might all be capital equipment.
The choices and the budget for them is usually decided on a company-wide basis. This is sometimes done through committees. These committees might receive funding and will need to rank their requests.
What Are the Characteristics?
It’s helpful to understand the breakdown of the characteristics that define capital equipment.
One of the main characteristics is cost. Again, one business may define capital equipment as more than $1,000, but others with more expensive needs might define it as more than $5,000. It can also be independent or supplementary. This means they could work alone or might need other equipment to function.
Another characteristic is durability, so these items must be durable and able to function for a year. These items are not bought with the intention to be sold or thrown away in the short term. They need to meet a certain threshold of use.
Size can sometimes also be a characteristic. Often, the term is associated with large items. This is not always the case. Something smaller like a defibrillator for a hospital would be considered capital equipment.
This type of equipment is also tangible and physical. This means the equipment needs to be items that can be touched and can be inventoried.
Finally, the use life is a characteristic. It doesn’t mean that the items are permanent and never depreciate, but they need to have a longer life than a year. Some even last a full decade. Essentially, these are items that are not purchased on a regular or recurring basis.
How is it Managed?
Some companies might decide on a life cycle management process to handle capital equipment. The process will involve the expectation that each asset will have a productive economic life, within a certain number of years. A piece of equipment can be considered within its economic life while it’s providing the company with more value than the cost to operate.
Asset managers and tax authorities will define different economic lives for each type of asset, like vehicles, machines, furniture, etc. If an asset is costing more than its return in value, then it is beyond its economic life. Managers will assess each asset’s performance occasionally. They will use profit metrics like ROI to establish the value of the equipment. Assets that are underperforming might be targeted for replacement.
Understanding the Basics
Capital equipment is important for the operations of a business. These items can help to construct and remodel spaces, or could be essential to the business function, like with transportation or testing equipment.
The basics of it can be understood by a few characteristics, like cost, durability and use life, and physical characteristics. What actually qualifies as capital equipment can vary depending on the industry and the company.
For more information about business funding or business services, and anything else you might need to understand about how your company’s finances work, check out our blog!