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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881

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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881
Textbook Problem
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Capital versus Revenue Expenditure

Warrick Water Company, a privately owned business, supplies water to several communities. Warrick has just performed an extensive overhaul on one of its water pumps. The overhaul is expected to extend the life of the pump by 10 years. The residual value of the pump is unchanged. You have been asked to determine which of the following costs should be capitalized as a part of this overhaul. Those costs not capitalized should be expensed.

Chapter 7, Problem 54E, Capital versus Revenue Expenditure Warrick Water Company, a privately owned business, supplies water , example  1

Chapter 7, Problem 54E, Capital versus Revenue Expenditure Warrick Water Company, a privately owned business, supplies water , example  2

* A requirement of the Occupational Safety and Health Administration that will add to maintenance costs over the remaining life of the pump.

Required:

CONCEPTUAL CONNECTION Classify each cost as part of the overhaul or as an expense. Be sure to explain your reasoning for each classification.

To determine

Concept introduction:

Capital Expenditures:

Capital expenditures are those which provide future economic benefits by improving the life, quality, efficiency of an asset. Some of the examples of capital expenditures are major improvements to the existing asset, remodelling and additions to the existing facility.

Revenue Expenditures:

Revenue expenditures occur frequently and they do not increase the future economic benefits from the asset and in fact they are expensed in the same accounting period in which the expenses are incurred. Some of the examples of revenue expenditures are maintenance and repair costs and costs involved in replacing minor items.

Requirement 1:

Classify the cost as overhaul or as an expense along with reasons for each classification.

Explanation

The following are the classification of elements of cost along with reasons:

New pump motor is a part of the overhaul since it is bought as an extensive overhaul for its water pumps and should be capitalized.

Repacking of bearings (performed monthly) should be expensed since it is a monthly expense incurred as part of maintenance of water pumps.

New impeller (rotating component of a pump) is a part of the overhaul since it is bought as an extensive overhaul for its water pumps and should be capitalized.

Painting of pump housing (performed annually) should be expensed since it is an ordinary repair and maintenance expense.

Replacement of pump foundation is a part of the overhaul since it is done to improve the performance of an existing asset hence it should be capitalized.

New wiring (needed every 5 years) is a part of the overhaul since it is done an addition to the existing asset hence it should be capitalized...

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