Once equipment has been installed and placed into 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 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? Can you share some real world examples (from your own experience) that demonstrate the various treatments?
There are several factors that one should take into consideration when making the decision of whether to charge expenditures to operations or capitalize them.
In order for the costs to be capitalized, one of these three conditions must be met:
1. The useful life of the asset must be increased.
2. The quantity of goods produced form the asset must be increased or the cost per unit must be decreased.
3. The quality of the goods produced must be enhanced.
To explain further, there are four major types of expenditures that may be incurred after an asset has been acquired. These are classified as additions, improvements, rearrangements, or repairs.
Additions, such as adding on to an existing building or installing a fire alarm system, are capitalized since a new asset has been created and the useful life of the asset is now increased.
Improvements and replacements can result when a building is modified. Improvements are substitutions of a better asset for the one currently used, such as replacing a wood roof with a metal roof. A re ...