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Dear OpenTuition,
There was a replacement of broken engine of Volkwagen van. However, the new engine is more powerful than the initial one. Will this cost be capitalized or it is a revenue expenditure of the period? My colleagues have different opinions on whether to consider it as a modernization or repair.
Thank you for your response.
I would assume that the ‘old’ engine is no longer available and that therefore there was no choice but to buy a more powerful engine. In this case it would be treated as revenue expenditure.
If, on the other hand, an engine could have been bought that was the same as the old engine, (and the difference in cost was material), then it would make more sense to treat the cost of a similar ‘old’ engine as revenue expenditure, and the extra cost as capital expenditure.
This would not, however. be asked in the Paper F3 exam 🙂
Thank you very much! Yes, ‘old’ type of engine is no longer available.
It is not a book question. It is a real situation we face now in our project.
It sounds like you’re asking about a real life problem rather than help with an exam question. So I’ll caveat my response by saying this forum is primarily for students helping each other with exams, so any response should not be relied upon for real life problems. I am not a qualified accountant (yet) so I am not qualified to give you advice on real life matters. Also, while I may be a moderator, I am not a tutor or representative of OpenTuition.
With that said, I would say it depends on whether the new engine actually increases the performance of the van and increases its usefulness as an asset and ability to deliver revenue. I would hazard a guess that for most cases e.g. a delivery van, a more powerful engine doesn’t increase the usefulness materially. The van still has to obey all the local speed limits and stop at traffic lights etc. so it’s unlikely it will be able to go much faster even with the new engine.
If the new engine doesn’t increase performance it can’t be capitalised IMO. It’s not part of a machine that can be continually replaced in parts – the main body of the van still has a finite life. So I would say it is a repair and should be expensed.
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