Ordinary Repairs

Ordinary repairs are the routine, recurring costs of maintaining property, plant and equipment in its normal operating condition. Examples include oil changes and tune-ups on vehicles, lubricating and adjusting machinery, replacing light bulbs, filters and belts, repainting, patching minor leaks and fixing broken windows. These costs do not extend an asset's useful life beyond its original estimate, increase its capacity or improve its output; they simply allow it to keep working as expected.

Because ordinary repairs benefit only the current period, they are recorded as an expense on the income statement when incurred, usually in an account called repairs and maintenance expense. This contrasts with an extraordinary repair, also called a major repair, which extends an asset's life or improves it and is therefore capitalized and depreciated over future periods.

Accountants usually ask whether the work:

• extends the asset's useful life beyond what was originally expected;
• increases its capacity, speed or productivity;
• improves the quality of its output or reduces its operating costs; or
• adapts it to a new or different use.

If none of these apply, and the work merely restores the asset to its previous condition or prevents it from deteriorating, it is an ordinary repair. The size of the bill is not the test: replacing a $3,000 worn conveyor belt that is expected to need replacement every two years is an ordinary repair, while a $3,000 upgrade that doubles the conveyor's speed is an improvement. Many businesses also set a capitalization threshold, such as $2,500 or $5,000, below which all such costs are expensed for simplicity, applying the concept of materiality.

A delivery company spends the following on its fleet of vans during the year: $18,000 on scheduled servicing, $6,500 on new tires, $4,200 on brake pads and $2,300 on repairs to dented panels. All of these keep the vans in normal operating condition and are expected to recur, so the company records repairs and maintenance expense of $31,000. The journal entry debits repairs and maintenance expense $31,000 and credits cash or accounts payable $31,000.

In the same year, it spends $45,000 replacing the engine in an older van that would otherwise have been retired, extending its life by four years. That is not an ordinary repair; it is capitalized and depreciated over the four extra years. Expensing the engine cost would have understated fixed assets and reduced current profit by $45,000, while increasing profit in later years by understating depreciation expense.

For federal income tax, the tangible property regulations issued by the Internal Revenue Service in 2013 set out when repair costs may be deducted. Costs must be capitalized if they result in a betterment, a restoration or an adaptation of a unit of property. Several safe harbors allow ordinary costs to be deducted: the routine maintenance safe harbor covers recurring work that a business expects to perform more than once during an asset's class life (or, for buildings, more than once in ten years), and the de minimis safe harbor lets businesses deduct items costing up to $2,500 per invoice or item, or $5,000 for businesses with audited financial statements. Small taxpayers with buildings of modest value can also elect to deduct small building repairs.

Getting the line right affects profit, asset values and tax. Expensing improvements understates assets and current profit, while capitalizing routine repairs inflates both, a tactic that has featured in accounting frauds. Auditors test large repair invoices and look for sudden changes in the ratio of repairs expense to capital expenditure. Analysts also note that cutting back on ordinary repairs can boost short-term profit, but deferred maintenance usually leads to larger costs and breakdowns later, so a sharp fall in repairs spending can be a warning sign rather than a saving.