Question

Question: Once equipment has been installed and placed in operation, subsequent expenditures relating to this equipment are frequently thought of as repairs or general maintenance and, hence, chargeable to operations in the period in which the expenditure is made. Actually, determination of whether such an expenditure should be charged to operations or capitalized involves a much more careful analysis of the character of the expenditure. What are the factors that should be considered in making such a decision? Discuss fully.

Short answer

Answer

A more acceptable procedure would be to remove the relevant amounts from the asset and accumulated depreciation accounts and capitalize the additional cost in the asset account.

Step-by-step solution

Meaning of Subsequent expenditure.

Those expenses incurred after an asset is recognized in the financial statement and transported to the location and condition intendedare termed subsequent expenditures. Costs such as repairs, maintenance, overhauls, upgrades, and replacements may be incurred.

Explaining the factors that should be considered in making such a decision.

Such expenses often comprise (1) regular maintenance costs to keep a property in good working order, (2) the cost of replacing structural sections of important plant units, and (3) the cost of significant overhauling operations that may or may not prolong the life beyond the initial estimate.

The first category of expenses covers day-to-day operations and is often charged to operations as incurred. These costs should not be included in the asset accounts.

The recorded cost of property may or may not be affected by the second category of expenditures. The renewal of parts does not normally affect the asset accounting if the asset is firmly defined as a distinct unit; nonetheless, these expenditures may be capitalized and allocated across numerous fiscal periods on an equitable basis. Such expenses should be charged to the plant asset accounts if the property is considered for structural elements amenable to separate replacement.

Major overhauls, the third type of expenditure, are normally recorded in asset accounts since they require the replacement of critical structural parts. Aside from the maintenance costs described above, there may be some radical expenses components of the asset that were not there at the time of purchase. These costs might be recorded in the asset account.

The Accumulated Depreciation account is frequently used to record expenditures that prolong the asset's life but not its use. Retiring the relevant amounts from the asset and the cumulative depreciation accounts (original cost from the asset account) and capitalizing the new cost in the asset account are more suitable. The initial cost of the item being replaced is often difficult to establish. As a result, the replacement or renewal expense is deducted from the Accumulated Depreciation account.