Capital Improvements After Asset Acquisition

After a long term asset such as property, plant and equipment has been acquired by a business, additional costs are often incurred which need to be classified as either capital improvements or repairs and mainteannce expenses.

The nature and classification of the costs as capital or repairs is important in accounting as capital improvements will be added to the original cost of the asset, included in the balance sheet, and depreciated over their useful life, whereas repairs will be treated as an expense of the business and included in the income statement for the year.

Capital Improvements

Each business will normally have a capitalization policy, for example a business might decide that expenditure must be greater than 3,000 and the useful life be greater than one year before being considered as capital expenditure.

Assuming the capitalization policy is satisfied, costs can normally be considered as capital improvements and added to the original capitalized cost of an asset for the following reasons.

  1. The asset is larger after the additional costs have be incurred such as for example, the addition of an extension to a building.
  2. The asset is improved beyond its earlier condition by the expenditure, making it for example more efficient to operate or more productive than when it was originally purchased,
  3. The asset is given an extended useful life by the expenditure.

Repairs and Maintenance Costs

Repairs and maintenance costs normally fall under the same expense heading. The distinction between the two is that a repair is undertaken to fix damage to an asset whereas maintenance is undertaken to prevent damage.

These costs are incurred to either return the asset to its earlier condition or maintain the asset in its current condition and do not improve it beyond that. In these circumstances they do not satisfy the capital improvement criteria listed above and therefore the cost is treated as an expense in the income statement of the business in the current year.

Capital Improvements and Repairs Example

Capital Improvement

Suppose a business incurs costs of 5,000 in installing network and fiber optic cabling in its office premises. The business has a policy to capitalize appropriate costs over 500 where the asset has a useful life of greater than one year.

The expenditure satisfies the capitalization policy of the business as it is over 500 and has a useful life greater than one year. Since the cabling has improved the building beyond its original state making it, among other things, more efficient, the cost is treated as a capital item and included in the balance sheet of the business.

The following capital improvements journal would be used to record the cost

Capital improvements journal entry
Account Debit Credit
Property, plant, and equipment 5,000
Accounts payable 5,000
Total 5,000 5,000

The 5,000 capital improvement cost is posted to a balance sheet account (property, plant and equipment). In subsequent years the capitalized cost amount will be depreciated over its useful life.

Repairs and Maintenance

In addition, the business incurs costs of 600 in carrying out repairs to electrical wiring.

Although the costs incurred are greater than the capitalization policy limit of the business, they simply return the electrical wiring to its normal condition and do not improve it beyond its original state. In these circumstances the costs are treated as an expense of the business and included in the income statement as a repairs expense.

The journal to post the expense is as follows.

Repairs expense journal entry
Account Debit Credit
Repairs expense 600
Accounts payable 600
Total 600 600

The cost of 600 is posted to an income statement account (repairs expense) and reduces the net income of the business for the year.

Capital Improvements After Asset Acquisition June 14th, 2017Team

You May Also Like

Related pages

semi annual amortization schedulecompute inventory turnoverperpetual accounting journal entriessundry in accountingperpetuity paymentrent due to landlord journal entrydoubling period formulacontribution margin exampleaccounting entries for accruals and prepaymentsdebtors days formulaconvertible bond accountingpresent value of ordinary annuity calculatornrv accountinginterest bearing loan definitionaverage account payable formulawhat is nsf checkis unearned revenue on the income statementgross margin equalsddb depreciationreceipt spreadsheet templatesales ledger control account definitionjournal entry to record accounts payablevertical analysis examplehow to calculate accounts payable on balance sheetsingle entry bookkeeping exampleaccounting spreadsheet templates for small businessintangible assets examples balance sheetdefine double entry bookkeepingcapital lease agreement templatefifo accounting calculatorpv of annuity calculatoractual manufacturing overhead costunits of activity depreciation calculatorhow to calculate irr in excelunfavorable labor rate varianceuncleared cheques in bank reconciliationpayroll suspense accountunadjusted trial balance worksheetslm methodpetty cash fund definitioncalculating markupdouble declining balance depreciation calculatorbond accounting journal entriescommon size cash flow statementbank reconsamortisation schedulelifo examplescreditors control account exampleannuity formula examplecreditors control account formatpaid cash dividends journal entrydays debtors outstandingstraight line discount amortizationbank voucher formatpresent value lump sum formulapresent value annuity calculationcash versus accrual accountingrecording capital leaseselling receivables with recoursefixed asset register excelwhy do you prepare a trial balanceaccounting equitionallowance for uncollectible accounts journal entryexamples of marketable securitiesbank reconciliation defineamortization schedule rule of 78importance of petty cash bookdiscount annuity formulahow to record write off of accounts receivabledefinition of bookeepingannuity factor formulanper excelentry for accrued incomecost sell margin calculator excelfactor account receivablecompounded continuously examples