Ordinary Repairs vs. Capital Improvements - Online Tutor, Practice Problems & Exam Prep

Understanding the distinction between ordinary repairs and capital improvements is crucial in accounting. Ordinary repairs, like routine maintenance, are expensed immediately on the income statement. In contrast, capital improvements, which enhance an asset's value or extend its life, are capitalized on the balance sheet. For example, greasing a machine is an ordinary repair, while modifying it to increase output is a capital improvement. This difference affects how expenses are recorded and ultimately impacts financial statements, including the income statement and balance sheet.

Ordinary Repairs vs. Capital Improvements

So once we own and use a fixed asset, we're going to have to maintain it. We might also spend more money to modify it or to expand its useful life. Let's check it out. We're going to be talking about Ordinary Repairs versus Capital Improvements here. An ordinary repair is standard maintenance, like an oil change for a truck. These are expenses and are expensed to the income statement. When we have ordinary repairs, we just expense them as they come along. But what about a capital improvement? This is a more significant project where you modify the vehicle or other fixed assets and generally extend the life of that fixed asset. These capital improvements are not just expensed right away to the income statement. We capitalize them to the balance sheet. When we use the word "capitalize," it means to record an expense as an asset, creating an asset on the balance sheet. Usually, if it's, for example, a truck, and we value the truck, if it's a debit an asset on our balance sheet, then we're going to increase that asset with this capital improvement. Okay?

Let's check out this example and see what I mean. We've got Ordinary Repairs and Capital Improvements. Let's see where each of these fall. A company has owned a machine for several years. During the current year, the company spent $150 to grease the gears of the machine. The company replaced several worn gears in the process at a cost of $500. The company also modified a segment of the machine to improve the capacity of its output at a cost of $2,000. Let's journalize these transactions, taking them one by one. The first was the greasing of the machine. When we grease the machine, this is standard maintenance. We need to lubricate these gears to make the machine work. This would be recorded as Maintenance Expense: $150, and let’s say we just paid for all of these with cash: Cash $150. That’s for greasing the machine. It would have just been a maintenance expense and would have gone straight to the income statement.

Now, the company replaced several worn gears at a cost of $500. This one is a bit tricky. Is it a capital improvement or an ordinary repair? This action isn't doing anything to realistically extend the life of the machine. You could argue that if we didn't change these gears, the machine wouldn't run anymore. But these are changes we'd probably expect to make over its useful life to ensure it keeps working properly. We're not really modifying the machine in any significant way. So, this is also going to be an expense. We'll record it as Maintenance Expense $500, and again, we'll say we paid with cash: Cash $500.

Lastly, the company modified a segment of the machine to improve the capacity of its output at a cost of $2,000. The wording here is a lot different than the other scenarios. While the others were plain and straightforward, this modification is enhancing the capacity. This is definitely a capital improvement. We're not going to debit Maintenance Expense in this case. We're going to debit Machinery because we're adding it onto the balance sheet. This extra money spent is going to be recognized as an asset and then depreciated over the useful life of the machine. This will eventually go to the income statement as Depreciation Expense, just like with the cost of the machine. Then, we'll credit Cash because we paid for this with cash.

That's the difference here. With a capital improvement, it’s going to increase the asset's balance itself, in contrast to ordinary expenses that go straight to the income statement as an expense. Alright? Let's pause here, and you guys can try and practice and categorize some things as either ordinary or capital. Let's check it out.

Categorize the following repairs on a truck as a Capital Expenditure or Ordinary Expense:

1. Major engine overhaul:

2. Oil change:

3. Replacement of windshield:

4. Modification of the body of the truck:

5. Addition to storage capacity of the truck:

6. Paint job:

Alright. Let's see how you guys did. Sometimes these can be a little tricky. The wording is everything here and I could see how there's a lot of gray areas sometimes. So let's go ahead and check these out. The first one, major engine overhaul. Notice, it said major. This is a big deal, right? A major engine and an overhaul is another big word here. Major engine overhaul. We're talking about changing the engine in the truck. Well, this is a capital expenditure. Okay? So this would increase the value of the truck as an asset. So, so yeah. Major engine overhaul. Capital expenditure. How about the next one? An oil change. Well, this is an ordinary repair. Right? This is every few months we got to do something like this. So that's an ordinary repair. How about the next one? Replacement of the windshield. This one for a lot of students would be in the gray area. Is it a capital expenditure? Not really, right? This isn't really a big deal of what we're doing. We're just replacing the windshield. This isn't modifying the truck in some big way. We're not doing some big change to it. You know, the windshield could get cracked overtime. And we're just going to have to replace it to keep using the truck. This ends up being an ordinary repair. How about the next one? Modification of the body of the truck. That one sounds pretty good, right? We're modifying the truck. It sounds like a pretty big deal here. We're modifying it. This is going to be a capital expenditure. This doesn't sound like an everyday kind of thing that we might have to do there. Capital expenditure for this modification of the truck. How about the next one? Addition to storage capacity of the truck. This doesn't sound like an ordinary repair either, right? We're adding to the storage capacity. We're making it more useful for the company. So this is also a capital expenditure. And how about the last one? A paint job. Again, this one for students, can hit a gray area too. They might think this is a capital expenditure as well. Well, this is just an ordinary repair. That paint is going to chip away over time. We're not extending the life of the truck in any way. This is just maintaining the truck. Ordinary repair right there. Alright. So that's about it for this one. Let's go ahead and move on to the next practice.

Which of the following is not a capital expenditure?

• A. Replacing an old motor with a new motor in a factory machine
• B. The addition of a new wing to a building
• C. An overhaul of the company's heating system
• D. A tune-up of a company truck
• E. The cost of installing equipment

Here’s what students ask on this topic:

What is the difference between ordinary repairs and capital improvements?

Ordinary repairs are routine maintenance tasks, such as oil changes or greasing gears, that keep an asset in working condition. These costs are expensed immediately on the income statement. In contrast, capital improvements are significant modifications or upgrades that enhance an asset's value or extend its useful life, like modifying a machine to increase its output. These costs are capitalized on the balance sheet, meaning they are added to the asset's value and depreciated over time. This distinction affects how expenses are recorded and impacts financial statements differently.

How are ordinary repairs recorded in financial statements?

Ordinary repairs are recorded as expenses on the income statement. For example, if a company spends $150 to grease the gears of a machine, this cost is recorded as a maintenance expense. The journal entry would debit the maintenance expense account and credit cash or accounts payable. This immediate expensing reflects the routine nature of the repair and its role in maintaining the asset's current condition rather than enhancing its value or extending its life.

How are capital improvements recorded in financial statements?

Capital improvements are recorded on the balance sheet as an increase in the asset's value. For instance, if a company spends $2,000 to modify a machine to improve its output, this cost is capitalized. The journal entry would debit the machinery account and credit cash or accounts payable. This capitalization means the cost is added to the asset's value and depreciated over its useful life, spreading the expense over multiple periods rather than expensing it immediately.

Can you provide examples of ordinary repairs and capital improvements?

Examples of ordinary repairs include tasks like oil changes, replacing worn gears, or greasing machine parts. These are routine maintenance activities necessary to keep the asset operational. On the other hand, examples of capital improvements include modifying a machine to increase its output, adding a new engine to a vehicle, or installing a new roof on a building. These improvements enhance the asset's value or extend its useful life, making them capital expenditures.

Why is it important to distinguish between ordinary repairs and capital improvements?

Distinguishing between ordinary repairs and capital improvements is crucial because it affects how expenses are recorded and reported in financial statements. Ordinary repairs are expensed immediately, impacting the income statement and reducing net income for the period. Capital improvements are capitalized, increasing the asset's value on the balance sheet and spreading the expense over its useful life through depreciation. This distinction ensures accurate financial reporting and compliance with accounting standards, providing a clear picture of a company's financial health.