Learning Outcomes
After studying this article, you will be able to distinguish between repairs and improvements, explain why correct classification matters, and prepare journal entries to reclassify incorrectly posted items. You will apply ACCA double-entry bookkeeping principles to practical scenarios and identify the impact of these reclassifications on profit and the statement of financial position.
ACCA Maintaining Financial Records (FA2) Syllabus
For ACCA Maintaining Financial Records (FA2), you are required to understand how to classify and record expenditure on non-current assets correctly. This includes distinguishing between expenses and asset acquisitions, correcting misclassifications, and preparing appropriate journal entries. You should revise the following syllabus areas:
- The difference between expenses and non-current asset expenditure
- Criteria for classifying repairs versus improvements
- The impact of misclassification on financial statements
- Preparation of correcting journal entries for reclassification
- Posting journals and updating ledger accounts for asset and expense accounts
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.
- Expenditure on repairing a delivery van has been recorded as an addition to the van non-current asset account. What is the correct accounting treatment and why?
- Which of the following is usually classified as an improvement (capital expenditure) rather than a repair (expense)? a) Repainting office walls b) Extending a warehouse by constructing a new section c) Replacing a worn-out tyre on a company vehicle d) Cleaning factory machinery
- If a $1,200 invoice for office refurbishment was incorrectly posted to repairs and renewals, what journal entries are needed to correct this error?
- Briefly explain the impact on profit if expenditure that should be capitalised is treated as an expense.
Introduction
Distinguishing between repairs and improvements is fundamental for the accurate preparation of financial statements. Repairs should be treated as expenses in the current period, while improvements (which increase the capacity, value, or useful life of a non-current asset) are capitalised and depreciated over time. Misclassifying such expenditure can distort reported profits and asset values. This article will guide you on how to identify the correct classification and prepare the necessary journal entries to reclassify misposted amounts in line with FA2 requirements.
Key Term: repairs
Expenditure that restores an asset to its original condition or maintains it; these costs are charged as an expense in the period incurred.Key Term: improvements
Expenditure that enhances an asset's value, efficiency, or useful life beyond original levels; these costs are capitalised as non-current assets.Key Term: reclassification journal entry
A journal entry posted to move an amount from one ledger account to another when an error in classification has been identified.
Classification Principles: Expense or Asset?
Correctly classifying expenditure affects both the statement of profit or loss and the statement of financial position. The main tests are whether the work restores an asset to its original standard (repair/maintenance) or increases future economic benefits (improvement/capital).
Repairs (Revenue Expenditure)
Repairs restore an asset to its previous condition without improving it beyond its original state. Typical examples include fixing leaking pipes, repainting, or replacing worn components. These are charged directly to the profit or loss account as expenses.
Improvements (Capital Expenditure)
Improvements make the asset better than it was—that is, they increase its capacity, usefulness, or extend its useful life. Examples include building an extension, installing advanced equipment, or major structural upgrades. Improvements are capitalised and included on the statement of financial position as part of the asset's cost, then depreciated over time.
The Impact of Misclassification
Posting a capital improvement to repairs understates assets and profit (since the item is expensed immediately). Conversely, posting a repair as an asset overstates assets, overstates profit (by reducing the current expense), and distorts depreciation calculations.
Reclassification: Journal Entries
Where expenditure has been posted to the wrong type of account, a reclassification journal is required. This is typically detected during a review or when preparing the year-end accounts.
- If a repair was wrongly capitalised, reclassify it from the asset account to the relevant expense account.
- If an improvement was expensed, reclassify it from the expense account to the non-current asset account.
Prepare a narrative to explain the reason for adjustment, referencing supporting documentation if needed.
Worked Example 1.1
Scenario:
An invoice for $3,000 describes roof repairs, but it was posted to the building asset account. The year-end accountant identifies that this should be an expense.
Answer:
Debit: Repairs and Maintenance $3,000
Credit: Non-current Asset (Buildings) $3,000
(To reclassify the cost of roof repairs from asset cost to the correct expense account.)
Worked Example 1.2
Scenario:
A business pays $8,500 for installing new machinery that increases production capacity. The invoice was posted as an expense to repairs and renewals.
Answer:
Debit: Machinery (asset) $8,500
Credit: Repairs and Renewals $8,500
(To reclassify the capital expenditure and capitalise the machinery.)
Worked Example 1.3
Scenario:
$1,200 spent to repaint offices was incorrectly posted to the building asset account.
Answer:
Debit: Repairs and Maintenance $1,200
Credit: Buildings (asset) $1,200
(Reclassify routine maintenance from asset to expense.)
Exam Warning
Incorrectly capitalising repairs leads to an overstatement of assets and profit in the current period. Misclassifying improvements as expenses reduces asset balances and can significantly understate profit.
Preparing Journal Entries for Reclassification
General Steps:
- Identify the original incorrect entry (e.g., repair posted to asset, or improvement posted to expense).
- Reverse the incorrect posting.
- Record the correct posting (if not already made by the reversal).
- Provide a clear narrative.
Example Format:
- Debit: Correct account (e.g., asset or expense)
- Credit: Incorrect account (e.g., expense or asset)
- Narrative: "To reclassify [description] from [incorrect] to [correct] account."
The Effect on Financial Statements
- Reclassifying an expense to a non-current asset increases both assets and future depreciation charges, reducing current-year expenses.
- Reclassifying a wrongly capitalised repair to an expense reduces asset values and increases current-year expenses, decreasing profit.
Key Point Checklist
This article has covered the following key knowledge points:
- Distinguish between repairs (expenses) and improvements (capital)
- Understand the effect of misclassification on profit and assets
- Prepare reclassification journal entries for errors
- Recognise the need for narrative explanations and supporting documentation
- Identify impacts on both the statement of profit or loss and statement of financial position
Key Terms and Concepts
- repairs
- improvements
- reclassification journal entry