Fixed assets — such as a truck — represent useful items a company can use for many years. Businesses may need to overhaul a vehicle or other fixed asset to keep it working properly. Accountants label these activities as asset improvements or capital expenditures. This keeps the transaction separate from regular fixed asset accounts.
Fixed Assets Defined
When companies purchase property, plants or equipment, they record the items in a general ledger as fixed assets. This adds value to the company and increases a company’s net equity. Assets reside on the balance sheet for review by financial statement users. Accountants will need to depreciate fixed assets, even vehicles. The historical cost of fixed assets is an essential piece of the depreciation process. Therefore, companies cannot record improvements or fixed assets in this account.
Purchasing a replacement engine for a vehicle is an asset improvement or capital expenditure. Accountants can capitalize these costs rather expense them immediately after purchase. Capitalization allows accountants to record the cost as an asset and expense a portion of the cost over time. This process is similar to depreciation. A significant difference is that the asset itself has a continued useful life due to the improvements, not the actual asset itself.
Accounting requires companies to separate fixed assets and asset improvements or capital expenditures. This allows for a clear representation of how much money a company spends on improving current fixed assets. In some cases, asset improvements are necessary to avoid the full replacement of a fixed asset. Expensing capitalized costs over time represents the use of improvements to help a company generate more revenues.
Accountants often create a schedule for asset improvements or capital expenditures. This allows for reference on all expenditures capitalized by a company. Accountants may also need to audit the schedule to ensure no costs remain once a company takes an asset out of service. Public accounting firms will also audit this schedule to ensure companies are not improperly capitalizing costs to reduce expenses and increase net income artificially.