Communication Case : Capitalize or expense; materiality
The focus of the case is the situation described in Case 1 . Your instructor will divide the class into two to six groups depending on the size of the class. The mission of your group is to determine the treatment of the overhaul expenditures.
Required:
1. Each group member should deliberate the situation independently and draft a tentative argument prior to the class session for which the case is assigned.
2. In class, each group will meet for 10 to 15 minutes in different areas of the classroom. During the meeting, group members will take turns sharing their suggestions for the purpose of arriving at a single group treatment.
3. After the allotted time, a spokesperson for each group (selected during the group meetings) will share the group's solution with the class. The goal of the class is to incorporate the views of each group into a consensus approach to the situation.
Case 1: Capitalize or expense; materiality
Redline Publishers, Inc. produces various manuals ranging from computer software instructional booklets to manuals explaining the installation and use of large pieces of industrial equipment. At the end of 2016, the company's balance sheet reported total assets of $62 million and total liabilities of $40 million. The income statement for 2016 reported net income of $1.1 million, which represents an approximate 3% increase from the prior year. The company's effective income tax rate is 30%.
Near the end of 2016, a variety of expenditures were made to overhaul the company's manufacturing equipment. None of these expenditures exceeded $750, the materiality threshold the company has set for the capitalization of any such expenditure. Even though the overhauls extended the service life of the equipment, the expenditures were expensed, not capitalized.
John Henderson, the company's controller, is worried about the treatment of the overhaul expenditures. Even though no individual expenditure exceeded the $750 materiality threshold, total expenditures were $70,000.
Required:
Should the overhaul expenditures be capitalized or expensed?