You are the CFO of Thunderduck Energy, Inc, a public company that specializes in

Question

You are the CFO of Thunderduck Energy, Inc, a public company that specializes in the exploration and development of natural gas. It's near year-end, and you have been in several meetings with management to discuss the end of year net income projections. The company’s employees receive a bonus if the company’s net income in the current year exceeds the net income from the past year. For the current year, the earnings have not been as strong as expected and net income may fall short of last year’s income. The President has an idea to ensure that net income will increase this year so that the employees will earn their bonus and the shareholders will be happy. The President wants to discuss routine maintenance costs on equipment that were incurred this year. These costs were treated as an expense on the income statement. However, the President is proposing that these costs can be capitalized and should be accounted for as a long-term asset on the balance sheet in order to boost the company’s net income. Required: Draft a one-page response in the form of a business memo to your manager discussing your recommendation on the President’s suggestion to capitalize the maintenance costs and record the costs as a long-term asset. Support your decision with addressing the accounting issue, the parties affected and what factors you considered to make your decision. Your memo will be graded based on the written communication, critical thinking and ethics rubrics.

Explanation / Answer

To: The Manager

From: Chief Financial Officer

Date: 30/12/2017

Re: Capitalization of Maintanence Cost of Equipment

The purpose of this letter is to give my opinion on the recommendation given by the President of the company to capitalize the maintanence cost of the equipment and account for as long term asset instead of treating them as expenses in the income statement.

As far as accounting issue is concerned the entry for recording the routine maintenance expense should be:

When Incurred:

Repairs and Maintenance A/c

           To Cash/Creditor

At the year end:

Income Statement A/c

           To Repairs and Maintenance A/c

However the extraordinary repairs which enhances the life and efficiency of the asset should be capitalized and not debited to the income statement. But if the repairs are of general nature then these should be charged against the Income Statement.

Factors Considered:

1. Cost of the repais which do not enhances the future economic benefits of the asset beyond its previously estimated standard of performance is revenue in nature and thus charged to the income statement.

2. High Value spare when replaced by a new spare and is reconditioned which is expected to increase the future economic benefits of the asset is capitalized. But in the given scenario the expenses are routine in nature and thus can not be capitalized.

3. Another point that should be kept in mind is that any abnormal cost, fines, penalties should not form part of the repairs cost.

Conclusion:

Based on above factors, as per my opinion routine maintenance cost should be charged to Income Statement and not to be shown as as asset otherwise it would inflate the profit which would be not be a true and fair presentation of the transactions and events.

Thanking You

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