Extraordinary Repair

An extraordinary repair is a significant repair to a long-lived asset that does more than keep it in normal working order. It extends the asset's useful life, increases its capacity or output, or otherwise improves it beyond its original condition. Because the benefit reaches into future years, the cost is capitalized, meaning it is added to the asset's carrying amount on the balance sheet and expensed gradually through depreciation, rather than being charged to expense all at once.

Extraordinary repairs are contrasted with ordinary repairs, the routine maintenance such as oil changes, painting and replacing small parts that simply keeps an asset running as expected. Ordinary repairs are recorded as repairs and maintenance expense on the income statement in the period they occur. The distinction is part of the broader question of when spending counts as a capital expenditure and when it is a revenue expenditure.

Accountants usually ask whether the work produces a future benefit that did not exist before. A repair is generally treated as extraordinary when it does at least one of the following:

• It adds years to the asset's useful life, as when a delivery truck receives a new engine that lets it run for four more years.
• It increases the asset's productive capacity, as when a machine is rebuilt to produce more units per hour.
• It improves the quality of the output or lowers operating costs in a lasting way.
• It is large in amount relative to the asset and does not recur every year.

Most companies also set a capitalization threshold, such as $5,000, below which all repairs are expensed for simplicity. In the United States, the Internal Revenue Service's tangible property regulations use a similar "betterment, restoration or adaptation" test for tax purposes, which is why companies often keep their book and tax policies aligned.

There are two common ways to record an extraordinary repair. When the repair mainly extends the asset's life, many textbooks debit accumulated depreciation, on the reasoning that the repair "restores" depreciation already taken. When it mainly increases capacity or quality, the cost is debited to the asset account itself. Either way the asset's net book value rises.

Suppose a machine cost $100,000, had an expected life of ten years and no salvage value, and is depreciated straight-line at $10,000 a year. After six years its accumulated depreciation is $60,000, so its book value is $40,000. The company then spends $20,000 overhauling it, which extends its remaining life from four years to six.

• The journal entry debits accumulated depreciation for $20,000 and credits cash for $20,000.
• The new book value is $40,000 plus $20,000, or $60,000.
• Revised annual depreciation is $60,000 divided by the six remaining years, or $10,000 a year.

Past depreciation is not restated. The new figure applies from the date of the repair forward, which is how a change in accounting estimate is handled under both US GAAP and IFRS.

Getting the line wrong distorts both profit and assets. Expensing an extraordinary repair understates assets and depresses income in the year of the repair, then overstates income in later years when no depreciation is charged for the improvement. Capitalizing ordinary repairs does the opposite, inflating current profit. Some of the largest accounting frauds, including the WorldCom case uncovered in 2002, involved recording billions of dollars of ordinary operating costs as capital assets. Auditors therefore review significant repair invoices, compare them with the company's capitalization policy and check that the related depreciation expense has been recalculated. Under IFRS, IAS 16 reaches a similar result by requiring a replaced major component of fixed assets to be capitalized and the old part derecognized, an approach known as component accounting.