A company owns a fleet delivery truck. During the year, it spends $500 on an oil change and tire replacement to keep the truck operating as originally intended, and separately spends $15,000 to replace the truck's engine with a new, higher-capacity engine that extends the truck's total useful life by three years and increases its towing capacity beyond the original specification. Under US GAAP, how should each expenditure be treated?
- Both expenditures are capitalized, because any cost incurred to maintain or improve an asset already in service is added to its carrying amount
- Both expenditures are expensed as incurred, because costs incurred after an asset is placed into service are always period costs under US GAAP
- The $500 in routine maintenance is expensed as incurred, because it merely maintains the truck's originally intended service potential, while the $15,000 engine replacement is capitalized, because it extends the truck's useful life and increases its capacity beyond the original condition
- The $500 in routine maintenance is capitalized because it is necessary to keep the asset functional, while the $15,000 engine replacement is expensed because it replaces rather than adds to the existing asset
Why C? And why not the others?
Correct answer: C. The $500 in routine maintenance is expensed as incurred, because it merely maintains the truck's originally intended service potential, while the $15,000 engine replacement is capitalized, because it extends the truck's useful life and increases its capacity beyond the original condition
Under US GAAP's general principle for subsequent expenditures on property, plant, and equipment, costs that merely maintain an asset's originally intended level of service — ordinary repairs and maintenance such as an oil change and tire replacement — are expensed as incurred, because they do not add future economic benefit beyond what the asset already provided. Costs that extend an asset's useful life, increase its capacity, or improve its efficiency beyond its original condition are capitalized as betterments, because they create additional future economic benefit. The $15,000 engine replacement does both: it extends the truck's useful life by three years and increases its towing capacity beyond the original specification, so it is capitalized (typically with any remaining carrying amount of the replaced engine derecognized). The option capitalizing both expenditures ignores the routine-maintenance exception and would overstate the asset's carrying amount with costs that create no incremental benefit. The option expensing both expenditures ignores that betterments extending useful life or capacity are specifically capitalized, not treated as automatic period costs just because the asset is already in service. The option reversing the treatment — capitalizing routine maintenance and expensing the betterment — inverts the standard distinction between maintaining existing service potential (expense) and enhancing it (capitalize).
Source: FASB ASC 360-10-30 (subsequent costs — repairs and maintenance versus betterments/improvements to property, plant, and equipment)