Definition
The financial accounting term improvements and replacements refers to a category of cost subsequent to acquisition. A replacement occurs when a similar asset is substituted for the original asset, while an improvement involves the substitution for a more advanced asset.
Explanation
Subsequent to assets being placed into service, they oftentimes require additional investments to either improve or maintain their productivity. Improvements and replacements are one of four categories of these investments; the others include additions, reinstallations and rearrangements, and repairs.
To capitalize costs associated with existing property, plant, and equipment, one of the following three conditions must be met:
The quality of output is enhanced in some manner. The units produced contain functionality that was not present prior to the investment.
The useful life of the asset is extended. For example, the expected service life of the asset is longer after the investment.
The capacity or productivity of the equipment increases. The units of output are higher.
As companies strive to increase their operating efficiency, they may look to replace or improve existing assets. As part of that continuous process, accountants need to classify the cost as either an expense or capitalize it to the proper property, plant, and equipment asset. If the cost satisfies one of the above capitalization tests, the company has three options:
Substitution: if the cost of the original asset is known, it should be removed from the company's books and the new asset's cost added.
Addition: the company can assume the original asset has been sufficiently depreciated such that the carrying cost on the books is near zero. The cost of the new asset is added to the company's asset base. This option is typically selected with improvements.
Book to Accumulated Depreciation: this final option may be selected when the new asset extends the life of the existing asset. The argument would be the replacement has effectively eliminated some of the accumulated depreciation of the existing asset. Lowering the balance found in the contra asset account of accumulated depreciation effectively capitalizes the cost of the replacement.
Related Terms
- The financial accounting term property, plant, and equipment is used to describe assets of a long lasting nature, which are used in the normal operation of the company. The most common types of property, plant, and equipment are land, buildings, and machinery.
Moneyzine EditorSeptember 21st, 2023 
The financial accounting term costs subsequent to acquisition refers to additional expenditures associated with property, plant and equipment. In general, companies make four types of investments in existing assets: additions to plant, improvements, reinstallations and repairs.Moneyzine EditorNovember 6th, 2024
The financial accounting term additions to property, plant, and equipment refers to one type of cost subsequent to acquisition. Additions are defined as an increase or expansion of these assets and the cost is typically capitalized.Moneyzine EditorJanuary 4th, 2024- The financial accounting term reinstallation and rearrangement refers to a category of cost subsequent to acquisition. A rearrangement or reinstallation occurs when equipment is moved from one location and installed in another. This is typically performed to increase production at the receiving location.Moneyzine EditorSeptember 21st, 2023
- The financial accounting term repairs to property, plant, and equipment refers to a category of cost subsequent to acquisition. Repairs are typically broken down into two subcategories: ordinary and major. Ordinary repairs are typically expensed, while major repairs may be capitalized if certain criteria are met.Moneyzine EditorSeptember 21st, 2023
The financial accounting term disposition of property, plant, and equipment refers to the disposal of the company's assets. This can include the sale, exchange, abandonment, and involuntary termination of the asset's service. Disposition of plant typically results in a gain or loss appearing on the company's income statement.Moneyzine EditorJanuary 16th, 2024- The term sale of property, plant, and equipment refers to the selling or exchange of the company's assets. When the sale of property, plant, or equipment occurs, the company must compare the asset's original purchase price and accumulated depreciation to its selling price to determine if there was a gain or loss on the transaction.Moneyzine EditorSeptember 21st, 2023
The term involuntary conversion refers to the unscheduled termination of property, plant, and equipment's service as the result of an unwanted event such as a fire, flood, or even theft. When the involuntary conversion of assets occurs, the company must compare the assets' original purchase price and accumulated depreciation to the disposition price to determine if there was a gain or loss on the conversion.Moneyzine EditorNovember 6th, 2024- The financial accounting term service life is used to describe the period of time over which an asset can be expected to perform its intended use. Service life is typically limited by two factors: physical wear and obsolescence.Moneyzine EditorSeptember 21st, 2023
