Repairing or modernising a fixed asset: when is the cost a period expense, and when does it increase the asset's value?

In one month the "Nafis Tikuv" workshop received three invoices: the sewing machines were repaired, the air conditioner in the office was fixed, and an automatic module was installed on the cutting line. All three are "money spent on equipment". Yet the chief accountant, Nodira, recorded them in three different ways.

She asked just one question: after the work, is the equipment better than before, or has it simply been brought back to its previous condition?

Where does the standard draw the line?

NAS No. 5 clearly separates two situations.

The first: the costs of keeping an asset in working order, including the costs of routine, medium and major (capital) repairs, are included in the expenses of that period. For a fixed asset used in production they go to the cost of products, and for a fixed asset used for administrative purposes they go to period expenses (paragraph 50).

The second: the costs of additional construction, additional equipping, reconstruction, modernisation and technical re-equipment increase the asset's initial cost if, as a result, the standard performance indicators originally adopted (useful life, capacity, quality of use and others) improve (paragraph 26).

So the criterion is the result, not the amount. However impressive the name "major repair" may sound, it is not added to the value.

How were Nodira's three invoices recorded?

Amounts are hypothetical; VAT is not shown for simplicity.

1. Routine repair of the 8 sewing machines in the workshop, contractor's service 3 600 000 soum. This is production equipment, so the expense goes to production overheads and then to the cost of products (NAS No. 21, paragraph 128).

2. Repair of the office air conditioner, 900 000 soum. A fixed asset serving general management, so it is an administrative expense (NAS No. 21, paragraph 409).

3. An automatic module for the cutting line, 30 000 000 soum. The line now cuts more fabric per hour than before: its capacity has increased. This is modernisation. The cost is first accumulated in capital investments and, once the work is finished, transferred to the value of the fixed asset.

How does depreciation change after modernisation?

The line was bought for 60 000 000 soum, its useful life is 5 years (60 months), and the method is straight-line: 60 000 000 / 60 = 1 000 000 soum a month. Over three years (36 months) wear of 36 000 000 soum has accumulated in 0230, and the carrying amount is 24 000 000 soum.

After modernisation, 0130 shows 90 000 000 soum and 0230 shows 36 000 000 soum, so the carrying amount is 54 000 000 soum.

According to the definitions in paragraph 3 of NAS No. 5, for such an asset the depreciable amount is the carrying amount (less the residual value) at the moment the work is finished and the asset is put into use, and the useful life is counted from that moment. If the residual value is taken as zero and the new period as 4 years (48 months):

Calculation: 54 000 000 / 48 = 1 125 000 soum. Since this is production equipment, the entry is Dt 2510 – Ct 0230 (NAS No. 21, paragraph 128).

One more subtle point: if the line was completely shut down during modernisation, no depreciation is charged for that period (NAS No. 5, paragraph 35).

What should you do to avoid mistakes?

• Have the content of the work stated precisely in the contractor's certificate of completion. What decides the matter is not the word "repair" or "modernisation" on paper, but what changed in the equipment
• Attach to the documents a technical opinion or measurement results showing that capacity, productivity or useful life has increased
• If one contract covers both repair and modernisation, split the amount by type of work: one part goes to expenses, the other to the value
• If an independent component with its own useful life is replaced within a fixed asset, this is not a repair: the old component is derecognised and the new one is accounted for as a purchase (NAS No. 5, paragraph 51)