What Is Capital Equipment
Capital equipment is generally defined as the acquisition cost which exceeds a set amount. To call it a capital asset it must have a life span of more than one year. The items must also assist in producing a product to be called capital equipment. Capital equipment can include items that are acquired in various ways; it can be purchased, leased or donated. Items that are included vary from company to company. For example in educational institutions capital equipment may include computers, microscopes, lab machinery etc.
Maintaining records of capital equipment is considered very important. Accurate inventory is one method of paperwork that any government generally requires. For this reason and for tax calculations purposes, disposing capital equipment procedure is strictly followed. To maintain warranty and to claim insurance various types of paper works is available. Capital equipment can also have a negative impact on the company’s profits. If too much of money is spent on acquiring this equipment then profits can be reduced.
If quality capital equipment is acquired and is used efficiently, then it can drastically enhance the profits. Fewer repairs and maintenance prevent losses. When equipment is kept and used for longer periods instead of being upgraded, it also adds to the profits of the company. To bring this into effect well planned capital equipment planning is necessary. Let us understand what is capital equipment planning?
Planning for purchasing of and replacement of capital equipment keeping in view the purpose for purchase, replacement, which includes obsolescence, desire for increased capacity and introduction of new product, is called capital equipment planning. Why is there a need for this plan? Equipment is becoming obsolete; to purchase an equipment to increase productivity, find best option in investing capital equipment.
In order to plan this well companies resort to capital budgeting. It is process of determining how a firm should allocate capital resources to avail long term investment opportunities. The companies should consider the time value money, incremental cash flows and rate of return from that particular project while doing this kind of capital budgeting.
Companies uses various capital budgeting techniques, let us discuss a few here:
- Pay back period: it is time taken for an investment to pay for itself or recoup the initial outlay. But this type of technique does not take the time value of money as said earlier and also consider cash flows after the pay back period.
- The net present value method: the sum of the present values of all the annual net cash flows minus the initial investment. But the greatest disadvantage of this method is when there are two projects it can’t easily compare if they differ in size.