How do firms account for expenditures to maintain or improve long-lived assets?

Answer 1

ADDITIONAL EXPENDITURES TO MAINTAIN OR IMPROVE LONG-LIVED ASSETS

Firms often incur costs to maintain, repair, and improve their tangible assets. Distinguishing between these purposes affects reported income because U.S. GAAP and IFRS require firms to treat expenditures for maintenance and repairs as expenses of the period as incurred but treat expenditures for improvements as assets (which firms subsequently depreciate or amortize).

Maintenance and Repairs

A firm incurs costs to keep its tangible assets in their expected operating condition. Maintenance includes routine costs such as for cleaning and adjusting. Repairs include the costs of restoring an asset's service potential after breakdowns or other damage. Expenditures for these items do not extend the estimated service life or increase its productive capacity beyond original expectations. Therefore, U.S. GAAP and IFRS treat such expenditures as expenses of the period when the firm makes the expenditure. In practice, distinguishing repairs from maintenance is difficult but typically not necessary because expenditures for both are period expenses.

Improvements

Expenditures for improvements, sometimes called betterments, increase an asset's performance by, for example, increasing the service life, or reducing the operating costs, or increasing the rate of output. Expenditures that increase service potential meet the definition and recognition criteria for an asset under both U.S. GAAP and IFRS. That is, a firm accounts for the expenditures as if it had acquired new benefits. When the firm makes the expenditure, it capitalizes the cost of the improvement by debiting the existing asset account (or a new asset account). Regardless, subsequent depreciation charges will increase because of the increased investment in depreciable assets.

Distinguishing Maintenance and Repairs from Improvements

Expenditures on maintenance and repairs have different income effects than expenditures on improvements. Some expenditures may both repair and improve. Consider expenditures to replace a roof damaged in a hurricane. If the new roof is purposefully designed to be stronger than the old one so that it will support the air conditioning equipment the firm plans to install, part of the expenditure represents repair and part represents improvement. Firms must make judgments and allocate costs between maintenance and repairs and improvements using professional judgment and all available evidence.