Question

You are the CFO of Thunderduck Energy, Inc, a public company that specializes in the exploration and development of natural gas. It's near year-end, and you have been in several meetings with management to discuss the end of year net income projections. The company’s employees receive a bonus if the company’s net income in the current year exceeds the net income from the past year. For the current year, the earnings have not been as strong as expected and net income may fall short of last year’s income.

The President has an idea to ensure that net income will increase this year so that the employees will earn their bonus and the shareholders will be happy. The President wants to discuss routine maintenance costs on equipment that were incurred this year. These costs were treated as an expense on the income statement. However, the President is proposing that these costs can be capitalized and should be accounted for as a long-term asset on the balance sheet in order to boost the company’s net income.

Required question:

How would I draft a response in the form of a business memo to my president discussing my recommendation on the President’s suggestion to capitalize the maintenance costs and record the costs as a long-term asset.

*Support the decision with addressing the accounting issue, the parties affected and what factors you considered to make your decision.

Answer 1

18th February, 2018

XYZ

President

Thunderduck Energy Inc

Suject: Regarding capitalization of routine maintanence cost to the cost of the asset

Dear Sir,

As a Chief Financial Officer of the company, it is my foremost duty to discuss the issue of capitalizing the routing maintenance cost to the cost of the asset. Generally all those cost which are incurred to get the asset ready to use is capitalized and when the asset is ready to use then all those cost which are incurred to increase the expected life and expected future economic benefits will be capitalized. As far as routing maintenance cost is concerned, it is the cost which is incurred to maintain the expected life and use of the asset and not to enhance the same.

Thus, in my opinion and as per the Generally Accepted Accounting Principles, the routine maintenance cost is to be debited in the P&L Account and the treatment done is correct in the books of accounts.

Chief Financial Officer