CPA Exam - FAR (Financial Accounting and Reporting)Financial ReportingMedium
A company is considering whether to capitalize or expense certain expenditures related to its property, plant, and equipment. Which of the following expenditures would most likely be capitalized?
- ARoutine maintenance and repairs that keep equipment in normal operating condition.
- BExpenditures that significantly extend the useful life of an existing asset or increase its productive capacity.
- CCosts incurred to replace a minor component of machinery that does not extend its useful life or increase its capacity.
- DCosts of training employees to operate a newly acquired machine.
Show answer & explanationAnswer & explanation
Correct answer: B. Expenditures that significantly extend the useful life of an existing asset or increase its productive capacity.
Expenditures that significantly extend the useful life of an existing asset, increase its productive capacity, or improve its efficiency are considered capital expenditures and should be capitalized. These expenditures provide future economic benefits beyond the current period.
Why the other options are wrong
- A. Routine maintenance and repairs are expensed as they only maintain the asset's current condition, not improve it or extend its life significantly.
- C. Replacing a minor component without extending life or increasing capacity is typically considered a repair and expensed.
- D. Employee training costs are generally expensed as incurred, as they do not directly relate to the physical asset itself and their future benefits are often difficult to measure reliably.
Capital vs. Revenue Expenditures
Capital expenditures provide future economic benefits by extending an asset's life, increasing its capacity, or improving its efficiency, and are capitalized. Revenue expenditures only maintain an asset's current condition and are expensed.
- Capitalized costs become part of the asset's cost and are depreciated.
- Expensed costs affect net income in the current period.
- Judgment required for borderline cases.
- Increases in asset value or economic benefits are key indicators for capitalization.
Memory trick: Life or capacity up? Capitalize. Same-old-same? Expense.