Question

Discuss as comprehensively as possible, the accounting treatment that is normally given to each of the items namely, a) Additions, b) Major Repairs, and c) Improvements and Replacements. Cite examples and justify your answers.

Answer 1

(A) Additions :- Additions represent entirely new units or extensions and enlargements of old units. Expenditures for additions are capitalized by charging either old or new asset accounts depending on the nature of the addition.

Capital addition is the cost involved for adding new assets or improving existing assets within a business, also called capital expenditures.

Additions represent major expenditures that are capital in nature because they increase the service potential of the related building. Additions costing $50,000 or above should be capitalized.

To capitalize costs associated with existing property, plant, and equipment, one of the following three conditions must be met:

• The quality of output is enhanced in some manner. The units produced contain functionality that was not present prior to the investment.
• The useful life of the asset is extended.   For example, the expected service life of the asset is longer after the investment.
• The capacity or productivity of the equipment increases. The units of output are higher.

For example, expenses incurred during construction of a warehouse are not expensed immediately. The costs associated with building the warehouse, including labor costs and financing costs, can be added to the carrying value of the fixed asset on the balance sheet. These capitalized costs will be expensed through depreciation in future periods, when revenues generated from the factory output are also recognized.

(B) Major Repairs :- Expenditures to replace parts or otherwise to restore assets to their previously efficient operating condition are regarded as repairs. To be considered a major repair, several periods must benefit from the expenditure. The cost should be handled as an addition, improvement or replacement depending on the type of major repair made.

Major repairs involve large expenditures that extend the useful life of an asset. For example, the replacement of a building roof is considered a major repair if it allows the building to be used beyond its normal operating life. Or, the engine in a forklift is replaced, thereby extending the lifespan of the equipment. In accounting, major repairs are capitalized as assets and depreciated over time.

Minor repairs do not extend the useful life of an asset, and so are charged to expense as incurred.

A repair or alteration to an asset that is large in scope and significant cost implications which could result in dramatic changes in performance of the asset.

Depending on local codes and standards, Major Alterations will likely require Professional Engineering review and stamp. Some examples that fall under this definition:

• Modernization

2. A major repair may be less than a complete renewal of an asset and usually entails replacement of one or more components rather than an entire assembly. Some examples that fall under this category:

• Swap out
• Rebuild
• Overhaul
• Major Maintenance

(C) Improvements :- An improvement does not add to existing plant assets. Expenditures for such better¬ments represent increases in the quality of existing plant assets by rearrangements in plant layout or the substitution of improved components for old components so that the facilities have increased productivity, greater capacity, or longer life. The cost of improvements is accounted for by charges to the appropriate property accounts and the elimination of the cost and accumulated depre¬ciation associated with the replaced components, if any.

Replacements :- Replacements involve an "in kind" substitution of a new asset or part for an old asset or part. Accounting for major replacements requires entries to retire the old asset or part and to record the cost of the new asset or part. Minor replacements are treated as period costs.

Examples of capital improvements include things like replacing a roof, repiering the whole house, replacing walls, adding rooms, replacing fences, repainting, or replacing assets such as ovens, cooktops, rangehoods, blinds, carpets.