Question

In: Accounting

Rail Grinding Rail grinding is a maintenance activity conducted on railroad tracks that is designed to...

Rail Grinding Rail grinding is a maintenance activity conducted on railroad tracks that is designed to remove

irregularities and imperfections from the track in order to allow for faster travel speeds on the track and to increase

the lifespan of tracks.

a. Using the Conceptual Framework, evaluate whether the cost of rail grinding activities should be capitalized as

an asset or reported as an expense.b. Using SEC.gov, company filings, full text search, look for disclosures from companies in the industry to bench-

mark how the industry treats these costs. c. Also using SEC.gov, search for CORRESP between the SEC and BNSF railroad. Describe the SEC’s position

on this issue

Solutions

Expert Solution

Answer:

A) whether the cost of rail grinding activities should be capitalized as an asset or reported as an expense;

  • We capitalize rail grinding because it (1) extends rail life; (2) improves rail profile, which reduces derailments; (3) improves the rail surface, which reduces derailments; and (4) improves rail shape, which promotes better riding stability.
  • Elements of Financial Statements, defines assets as probable future economic benefits obtained by a company as a result of past events, and indicates that expenditures that extend the useful life of an asset are capitalizable if substantial.
  • Rail profile correction through grinding can extend the life of rail up to 2.5 times (average of curve and tangent track life extension).
  • The new thrust of grinding is to "gently" preserve the state of the top layer of the rail. The more a railway catches up with surface fatigue, the more conformal they can grind the rail to the average worn wheel. So while rail grinding can mitigate subsurface defects and reduce the risk of rail breaks, the future is in the control of the very start of the initiation process for rail fatigue.

Normal repairs and maintenance are also expensed as incurred, while costs incurred that extend the useful life of an asset are capitalised.

.

b) Fixed assets have two primary characteristics:

1.They are acquired for use in operations and enter into the revenue-generating stream indirectly. They are held primarily for use, not for sale.

.

2.They have relatively long lives.

Ballast meets both of these characteristics because it is critical in our revenue-generating stream (train operations would not be possible without ballast to provide stability to the rail and ties) and because it has a long life (34 years based on our most recent life study). Cost should not be the basis for determining whether a ton of ballast is a fixed asset. In our judgment, expensing the cost of an asset based on materiality is not consistent with GAAP.

.

c) Appropriate method of accounting for rail grinding is dependent on whether or not life-enhancing activities, such as rail grinding, are reflected in the anticipated rail asset life as established at the date of the financial statements.  Accordingly, the Company uses an initial asset life for rail that excludes the impact of future rail grinding activity and incrementally extends the useful life of the rail asset as the rail grinding activity is performed. The initial service life of the rail asset is set based on usage and is measured in millions of gross tons per mile (GTMs) , determined using railroad industry research and testing.

The estimated service life of the rail asset is then increased incrementally, although not to its maximum or ultimate life, as rail grinding is performed thereon. As such, the costs incurred for rail grinding extend the estimated useful life of the rail asset given that additional GTMs can be carried over the rail for its remaining service life.


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