Repairs and maintenance expense is the cost a business incurs to keep its property, plant and equipment in good working condition so that the assets continue to perform as originally expected. It covers routine servicing, cleaning, inspections, replacing small worn parts and fixing breakdowns. Typical examples are an oil change on a delivery van, repainting an office, servicing an air-conditioning system or replacing a broken window.
Because this spending maintains an asset rather than improving it, it is normally recorded as an expense in the period it occurs and reported among operating expenses, or within manufacturing overhead for factory equipment. The key accounting judgment is distinguishing it from spending that should be capitalized as part of the asset's cost.
Expense or capitalize
Spending on an existing asset is generally capitalized, meaning added to the asset's carrying amount and depreciated, if it does one or more of the following:
- Extends the asset's useful life beyond the original estimate.
- Increases its capacity, such as adding a floor to a building or a higher-output motor to a machine.
- Improves the quality of its output or reduces its operating costs significantly.
- Adapts it to a new or different use.
Such work is often called a betterment, an improvement or an extraordinary repair, and it is treated as a capital expenditure. Work that simply restores the asset to its previous condition, often called ordinary repairs, is treated as a revenue expenditure and expensed. Major repairs sit in between and need case-by-case judgment.
Worked example
A logistics company owns a truck with an original cost of $120,000 and accumulated depreciation of $60,000, with five years of life remaining. During the year it spends $2,400 on tires, brakes and routine servicing. It also pays $18,000 to rebuild the engine, which extends the truck's remaining life from five to eight years.
The $2,400 is recorded as a debit to repairs and maintenance expense and a credit to cash or accounts payable. It reduces this year's profit in full. The $18,000 engine rebuild is capitalized. One common method debits the truck asset account; another, which some textbooks prefer for life extensions, debits accumulated depreciation. Either way, the carrying amount rises from $60,000 to $78,000, and straight-line depreciation is recalculated over the new remaining life: $78,000 divided by 8 gives $9,750 a year, ignoring salvage value.
Had the rebuild been wrongly expensed, profit this year would be understated by $18,000 and future years' profits overstated by the extra depreciation that would have been charged.
US tax treatment
For federal income tax, the IRS tangible property regulations, issued in final form in 2013, set out when spending must be capitalized as an improvement. They use the idea of a betterment, a restoration or an adaptation to a new use. They also provide practical safe harbors. A routine maintenance safe harbor allows recurring work expected more than once during an asset's class life, or more than once in ten years for buildings, to be deducted. A de minimis safe harbor lets businesses deduct items costing up to $2,500 per invoice or item, or up to $5,000 for businesses with an audited financial statement. Small taxpayers may also use a safe harbor for small buildings. Book and tax treatment can differ, which can create deferred income taxes.
Analysts watch repairs and maintenance spending because cutting it can boost short-term profit while the asset base quietly deteriorates. A sharp fall relative to fixed assets may signal deferred maintenance. Conversely, a company that capitalizes too much routine work inflates its assets and profit, a practice that has featured in accounting frauds. Many businesses set a capitalization policy, for example expensing all items under $5,000, to keep treatment consistent.