## **Learning Outcomes**

After reading this article, you will be able to distinguish between repairs and improvements, decide whether expenditure is capital or revenue, and explain how these choices affect financial statements. You will also be able to define key terms, identify common exam pitfalls, and apply decision criteria to typical ACCA scenarios.

## **ACCA Maintaining Financial Records (FA2) Syllabus**

For ACCA Maintaining Financial Records (FA2), you are required to understand how to classify and record different types of expenditure on assets. For exam purposes, pay special attention to:

- Identifying and distinguishing asset (capital) and expense (revenue) items
- Applying criteria for capitalising or expensing expenditure on fixed assets
- Explaining the impact of misclassification on the statement of profit or loss and statement of financial position
- Preparing correct journal entries for acquisitions, repairs, and improvements

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. When is the cost of a new roof on a business property treated as a capital expenditure?
2. What is the main accounting difference between a repair and an improvement carried out on a company van?
3. True or false? All subsequent spending on non-current assets should be recorded as capital.
4. Which financial statements are affected by misclassifying a large improvement as an expense?

## **Introduction**

Classifying expenditure correctly as either an expense (revenue) or improvement (capital) is fundamental in accounting. The distinction impacts profit measurement and the valuation of assets. For ACCA FA2 candidates, confidently applying these criteria is assessed both directly and through practical scenarios. Precise understanding helps prevent errors that can distort financial statements.

> **Key Term: capital expenditure**
> The cost of acquiring or enhancing a non-current asset, providing benefits over several periods. Capitalised as an asset in the statement of financial position.
>
> **Key Term: revenue (expense) expenditure**
> Spending on day-to-day operations or restoring assets to their original working condition. Charged immediately to the statement of profit or loss.
>
> **Key Term: repairs**
> Work carried out to maintain an asset in its existing condition, ensuring continued use but not generally improving its value or life.
>
> **Key Term: improvements**
> Expenditure that upgrades an asset, extending its useful life, increasing its capacity, or improving its output beyond original specifications.

## Distinguishing Repairs from Improvements

Determining whether expenditure is a repair or improvement depends on its purpose and effect:

- **Repairs** are costs incurred to restore an asset to working order without enhancing value or productivity.
- **Improvements** make an asset better than when originally purchased, such as significant upgrades or extensions.

### Capital vs Revenue Expenditure: The Criteria

Ask the following questions to decide:

- **Does the expenditure provide new or additional future economic benefits?**
  - If yes, it is likely an improvement (capital).
- **Does it simply restore the asset to its original condition?**
  - If yes, it is a repair (revenue/expenditure).
- **Does the work modify the asset for a new use or extend its useful life?**
  - Significant adaptation or life extension should be capitalised.

> **Key Term: capitalisation**
> Recording expenditure as an asset rather than an immediate expense, recognising future economic benefit.

## Why the Distinction Matters

The way you classify expenditure affects:

- **Profit/loss:** Revenue expenditure reduces profit immediately. Capital expenditure spreads the cost via depreciation.
- **Asset values:** Capitalising improvements increases the recorded asset value, which can affect balance sheet ratios.
- **Tax and compliance:** Incorrect classification can have legal and regulatory consequences.

### **Worked Example 1.1**

A business replaces the worn tyres on its delivery van at a cost of \$600. Six months later, it fits a new engine that increases the van's carrying capacity, costing \$4,000.

**Question:** How should these two types of expenditure be classified and recorded?

> **Answer:**
> Replacement tyres restore the van's function and are a repair (revenue expenditure)—charged to the statement of profit or loss. The new engine improves the van beyond original specification, so it is an improvement (capital expenditure)—capitalised as part of the asset's cost.

### **Worked Example 1.2**

A shop owner redecorates the store (\$2,000) and, in the same period, adds an extra storage room for \$8,000.

**Question:** Which amounts are expenses and which are capital?

> **Answer:**
> The redecoration cost is maintenance (revenue), so it goes to expenses. The new storage room extends the shop’s capacity, so it is an improvement—recorded as a non-current asset.

### **Exam Warning**

> Misclassification is frequently tested. Recording improvements as expenses understates assets and overstates expenses, reducing profit. Charging major repairs as capital overstates profits and assets. Always justify your treatment by whether the work adds value or simply maintains.

## Effects of Misclassification

**Overstating profit:** Charging improvements as expenses means profits are higher in future years (since no extra depreciation is charged).

**Overstating assets:** Treating repairs as capital overstates the asset value and spreads costs incorrectly.

### **Worked Example 1.3**

Last year, a business replaced an old roof with a new, more durable design for \$30,000 but treated it as “repairs expense.”

**Question:** What is the impact of this misclassification?

> **Answer:**
> The asset in the statement of financial position is understated, and profits for the year are significantly reduced. Future period expenses are understated (since depreciation is lower), potentially misleading users of the accounts.

## Accounting Treatments and Entries

- **Repairs:** Debit Repairs Expense (statement of profit or loss)
- **Improvements:** Debit Non-current Asset (statement of financial position); depreciate over expected useful life

> **Key Term: depreciation**
> The systematic allocation of the cost of a non-current asset, including improvements, over its useful life.

## Practical Application Checklist

1. **Assess the nature of the expenditure:** Maintenance/restore? → Expense. Upgrade/extend/useful life? → Capital.
2. **Update records:** Add capital improvements to asset register; expense repairs as incurred.
3. **Review materiality:** Small upgrades may sometimes be expensed for practicality, but document your reasoning.

### **Revision Tip**

> Practice classifying mixed invoices containing both repairs and improvements—split the amounts and treat each according to the criteria.

## **Summary**

Deciding between repairs and improvements is key to preparing accurate accounts. Capital expenditure builds asset value and is depreciated over time; repairs sustain existing assets and are expensed immediately. Careful analysis is required for all significant spending. Proper classification ensures financial statements fairly present the business’s position and performance.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- The definition and distinction between capital and revenue expenditure
- How to determine whether spending is a repair or an improvement
- Accounting treatment for each type in financial statements
- Effects of misclassification on profit and asset values
- Typical journal entries for both repairs and improvements

## **Key Terms and Concepts**

- capital expenditure
- revenue (expense) expenditure
- repairs
- improvements
- capitalisation
- depreciation

Repairs vs improvements - Expense vs capital criteria