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Trueblood Case 99-04

In: Business and Management

Submitted By chickenman
Words 502
Pages 3
The Eye of the Potato

Brief facts:

Small Fries, Inc. has agreed with the Occupational Health and Safety Administration to undertake an “action plan” involving two of its plants, to bring them up to OSHA standards related to worker safety. The action plan includes an estimated $20 million of expenses, which we are told can be classified as repairs and maintenance. As the changes are to be completed within one year, the expenses have been budgeted into the 1997 operating budget. Small Fries intends to capitalize the repair costs, and has accrued none of them.

Question 1: Should the costs associated with OSHA compliance be capitalized as an asset, or charged to expense?

According to Keiso (Intermediate Accounting, 14th edition) accounting for improvements to assets is dependent on the type of improvements that are made, which is determined by asking whether the expenditure increases “future service potential”, or whether it simply maintains the existing level of service of the asset. Expenditures increasing future service potential should be capitalized, while maintenance should be expensed.

Future service potential is unfortunately left undefined by Keiso, but several other writers have described it as related to production or output of the company’s product or service. Under this commonly understood definition, an improvement to an auto assembly line allowing production of ten cars in the time it previously took to build eight, would clearly enhance future service potential. Looked at this way, the planned repairs at Small Fries appear to be maintenance. There is no indication that the improvements will cause increased production. The stated expected future benefits pertain to decreased worker injuries and improved morale, both of which are speculative, unquantifiable, and impossible to match with future expenses.

Maintenance of an asset…...

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