Week 3 Discussion 1: Operating vs Capital
Operating vs Capital – Explain the difference between an operating expense and a capital expense. Why is this an important distinction…
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Week 3 Discussion 1: Operating vs Capital
Paper details
Explain the difference between an operating expense and a capital expense. Why is this an important distinction?
Solution
Operating Expenses and Capital expenses
Operating and capital expenses play an integral role in running a business. However, operating and capital expenses serve different purposes and are treated differently in accounting. Operating expense is the money a business uses to facilitate its day-to-day operations. These expenses are accrued daily and immediate benefits to the business by facilitating the operational activities. For instance, office rent and utilities ensure the business is fully operational daily.
Since most operating expenses are incurred regularly, they are accounted for in the tax period (Hertvik, & Lange, 2021). Furthermore, the operating expenses also determine the costs the business needs to generate revenue. Hence, cost management and efficiency in the operating expenses help the business generate the most revenue despite a relatively lower operating expense.
Capital expenses are money used by the business to acquire, maintain, or upgrade assets that have a multi-year life and help in the business’s operations. Capital expenses are used for long-term assets such as buildings or machinery that has a beneficial response beyond the accounting period (Corporate Finance Institute, 2022). Hence, one attribute of capital expenses that stands out is that they are the expenses a business incurs to generate profit in the future.
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There is a clear distinction between operating expenses and capital expenses in accounting. In operating expenses, tax can be fully deducted during the incurred accounting period, while for capital expenses, the tax can be deducted through depreciation every year or the costs spread out during the useful life of the asset.
As such, capital expenses are assets in the balance sheet, investing activities in the cash flow statement, and depreciation in the expense account of the income statement (Hertvik & Lange, 2021). Operating expenses are listed under the operational expense section of the income statement. The distinction is important because the two expenses have different tax setups despite impacting the business’s current or future operations.
References
- Corporate Finance Institute. (2022). Operating Expenses. Corporate Finance Institute. Retrieved 10 May 2022, from https://corporatefinanceinstitute.com/resources/knowledge/accounting/operating-expenses/?msclkid=4dc9fcadcffa11ec9f929768b9ec3fa9.
- Hertvik, J., & Lange, K. (2021). CapEx vs. OpEx: Capital Expenditures & Operating Expenses Explained. BMC Blogs. Retrieved 10 May 2022, from https://www.bmc.com/blogs/capex-vs-opex/?msclkid=b1333e11d00011ecaacd48b9201e501a.
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