Which expenditure is best classified as an expense?

Which expenditure is best classified as an expense?

• A. Purchase of a replacement relief valve
• B. A maintenance contract for inspection and test of relief valves
• C. Purchase of a new production line
• D. Acquisition of an office building

Answer: (B)

The key idea is differentiating between costs that maintain current operations and those that create or extend a long-term asset. A maintenance contract for inspection and testing of relief valves is an operating cost: it covers ongoing services that keep equipment safe and functioning but don’t add to the asset’s value or life. Since it doesn’t bring a future benefit beyond the period in which it’s consumed, it’s expensed in the current period. In contrast, buying a new production line or acquiring an office building creates long-term assets, so those costs are capital expenditures and are capitalized and depreciation is used over their useful lives. A replacement valve could be a repair (expensed) or, if it meaningfully extends life, could be capitalized, but routine maintenance remains an expense.

The key idea is differentiating between costs that maintain current operations and those that create or extend a long-term asset. A maintenance contract for inspection and testing of relief valves is an operating cost: it covers ongoing services that keep equipment safe and functioning but don’t add to the asset’s value or life. Since it doesn’t bring a future benefit beyond the period in which it’s consumed, it’s expensed in the current period. In contrast, buying a new production line or acquiring an office building creates long-term assets, so those costs are capital expenditures and are capitalized and depreciation is used over their useful lives. A replacement valve could be a repair (expensed) or, if it meaningfully extends life, could be capitalized, but routine maintenance remains an expense.