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Does accumulated depreciation affect net income?

Regular repair and maintenance costs do not significantly improve the asset or extend its useful life beyond the original estimate, whereas extraordinary repairs do. On the other hand, expensing major repairs immediately offers a different set of advantages. This method provides a more conservative financial approach, reflecting the true cost of maintaining assets in the period they occur.

Related terms:

Since extraordinary repairs extend the life of the asset, they are not immediately expensed on the income statement like normal repairs are in the current year. Instead, extraordinary repairs are capitalized and reported on the balance sheet as an increase in value to the asset extraordinary repairs accounting they upgraded. Depreciation expense is another area significantly affected by the capitalization of major repairs. By spreading the repair costs over the asset’s extended useful life, the company can manage its expense recognition more evenly across multiple periods.

Which of these is most important for your financial advisor to have?

This spreads out the cost of the repairs over the periods that are expected to benefit from them. Fixed assets are then consolidated and presented in the long-term asset section on a company’s balance sheet. Recording extraordinary repairs in this manner also increases the periodic depreciation expense recorded over the revised remaining life of the asset.

Asset

In order to adequately maintain the docks and provide safe storage for its boats, ABC must routinely replace rotten or damaged boards on the docks. These costs are incurred as part of general maintenance and do not extend the life of the dock at all. This would be an ordinary repair, and the accountants at ABC would record the transaction as a debit to repairs expense and a credit to the cash balance. However, repairs that are part of a larger project, such as replacing all of a home’s windows, do qualify as capital improvements.

• IFRS emphasizes the economic substance of transactions over their legal form, which can sometimes lead to different interpretations and applications.
• Extraordinary repairs are capitalized, which means the repair cost increases the book value of the fixed asset that was repaired, increasing depreciation expenses over the revised remaining life of the asset.
• On the other hand, expensing the costs immediately would result in a substantial hit to net income in the period the repair is made, which could be detrimental to financial ratios and investor perceptions.
• The depreciation expense would be completed under the straight line depreciation method, and management would retire the asset.
• Because major and extraordinary repairs benefit multiple future periods, they are accounted for as additions, improvements, or replacements.
• This additional cost will flow through to the income statement over the course of those 10 years.

Taxes

The decision to capitalize or expense can have significant implications for a company’s financial health. Capitalizing major repairs spreads the cost over several periods, thereby reducing the immediate impact on net income. This can be particularly beneficial for companies looking to smooth out earnings and present a more stable financial picture.

Oil changes, tire rotations, and light bulb replacements are small expenditures that don’t really extend the life of the vehicle. Expenditures required to increase the performance level may result in the capitalization of the additional costs. For example, replacing the oil filter in a truck is considered a maintenance cost, while replacing the roof of a building extends the life of the building, and so its cost will be capitalized. Since the benefits of these repairs will extend into future periods, GAAP requires that we record this transaction as an additional asset. Sometimes these repairs are reported as a separate asset and sometimes they are reported as an addition to the existing asset.

Instead, an extraordinary repair is targeted at those parts of a machine that will wear out by the expected asset retirement date, so that the machine can continue to function for a prolonged period. Examples of extraordinary repairs are a new roof for a building, a new engine for a truck, and repaving a parking lot. Capital Expenditures (additions, betterment, extraordinary repairs) are debited to it’s corresponding asset account. The asset’s book value increases by the amount of Capital Expenditure and Depreciation is revised to show the cost recovery. These are not ordinary repairs and maintenance that are necessary to keep an asset operating day to day but rather significant expenditures that provide benefits extending beyond the current accounting period.

Understanding how to account for these repairs is essential for accurate financial reporting and compliance with accounting standards. Repairs and maintenance are expenses a business incurs to restore an asset to a previous operating condition or to keep an asset in its current operating condition. The risk transfer criteria discussed in this section provide a framework for determining whether there is a transfer of risk. If the contract transfers risk, FinREC believes the airline should recognize maintenance expense in accordance with the PBTH contract, as opposed to following its maintenance accounting policy. In these situations, FinREC believes there is a presumption that the expense should be recognized at a level rate per hour during the minimum, noncancelable term of the PBTH agreement.

My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career. Andy Smith is a Certified Financial Planner (CFP®), licensed realtor and educator with over 35 years of diverse financial management experience. He is an expert on personal finance, corporate finance and real estate and has assisted thousands of clients in meeting their financial goals over his career.