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- Repairs and maintenance are expenses a business incurs to restore an asset to a previous operating condition or to keep an asset in its current operating condition.
- Similarly, if a machine’s expected life is only prolonged by a few months, it is more efficient to charge the repair cost to expenses.
- Each separate legal entity has its own financial accounting processes and creates its own financial statements.
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- In order to adequately maintain the docks and provide safe storage for its boats, ABC must routinely replace rotten or damaged boards on the docks.
- Conversely, if a company opts to expense major repair costs immediately, the impact on the income statement is more pronounced in the short term.
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4 Maintenance, including major maintenance
Since extraordinary repairs extend the life of the asset, they are not immediately expensed on the income statement like normal repairs are in the current year. Instead, extraordinary repairs are capitalized and reported on the balance sheet as an increase in value to the asset they upgraded. Depreciation expense is another area significantly affected by the capitalization of major repairs. By spreading the repair costs over the asset’s extended useful life, the company can manage its expense recognition more evenly across multiple periods.
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Oil changes, tire rotations, and light bulb replacements are small expenditures that don’t really extend the life of the vehicle. Expenditures required to increase the performance level may result in the capitalization of the additional costs. For example, replacing the oil filter in a truck is considered a maintenance cost, while replacing the roof extraordinary repairs accounting of a building extends the life of the building, and so its cost will be capitalized. Since the benefits of these repairs will extend into future periods, GAAP requires that we record this transaction as an additional asset. Sometimes these repairs are reported as a separate asset and sometimes they are reported as an addition to the existing asset.
The debate between capitalizing and expensing major repairs is a nuanced one, often hinging on a company’s strategic objectives and financial philosophy. Capitalizing repair costs can provide a more favorable short-term financial outlook by spreading expenses over several periods. This approach can be particularly advantageous for companies aiming to present a stable earnings profile, which can be appealing to investors seeking consistent returns. By capitalizing, companies can also enhance their balance sheet, showing a higher asset base and potentially improving leverage ratios, which can be beneficial when seeking financing.
Understanding how to account for these repairs is essential for accurate financial reporting and compliance with accounting standards. Repairs and maintenance are expenses a business incurs to restore an asset to a previous operating condition or to keep an asset in its current operating condition. The risk transfer criteria discussed in this section provide a framework for determining whether there is a transfer of risk. If the contract transfers risk, FinREC believes the airline should recognize maintenance expense in accordance with the PBTH contract, as opposed to following its maintenance accounting policy. In these situations, FinREC believes there is a presumption that the expense should be recognized at a level rate per hour during the minimum, noncancelable term of the PBTH agreement.
The decision to capitalize or expense can have significant implications for a company’s financial health. Capitalizing major repairs spreads the cost over several periods, thereby reducing the immediate impact on net income. This can be particularly beneficial for companies looking to smooth out earnings and present a more stable financial picture.
In order to adequately maintain the docks and provide safe storage for its boats, ABC must routinely replace rotten or damaged boards on the docks. These costs are incurred as part of general maintenance and do not extend the life of the dock at all. This would be an ordinary repair, and the accountants at ABC would record the transaction as a debit to repairs expense and a credit to the cash balance. However, repairs that are part of a larger project, such as replacing all of a home’s windows, do qualify as capital improvements.
Regular repair and maintenance costs do not significantly improve the asset or extend its useful life beyond the original estimate, whereas extraordinary repairs do. On the other hand, expensing major repairs immediately offers a different set of advantages. This method provides a more conservative financial approach, reflecting the true cost of maintaining assets in the period they occur.
This spreads out the cost of the repairs over the periods that are expected to benefit from them. Fixed assets are then consolidated and presented in the long-term asset section on a company’s balance sheet. Recording extraordinary repairs in this manner also increases the periodic depreciation expense recorded over the revised remaining life of the asset.
Instead, an extraordinary repair is targeted at those parts of a machine that will wear out by the expected asset retirement date, so that the machine can continue to function for a prolonged period. Examples of extraordinary repairs are a new roof for a building, a new engine for a truck, and repaving a parking lot. Capital Expenditures (additions, betterment, extraordinary repairs) are debited to it’s corresponding asset account. The asset’s book value increases by the amount of Capital Expenditure and Depreciation is revised to show the cost recovery. These are not ordinary repairs and maintenance that are necessary to keep an asset operating day to day but rather significant expenditures that provide benefits extending beyond the current accounting period.
