Reference no: EM132000306

Question: A messenger/delivery service company owns a fleet of six minivans. Each driver is responsible for scheduling routine maintenance on his or her van, including oil changes, tune-ups, and tires. The owner of the company learned that one of the drivers has neglected to schedule regular maintenance. His van, which is 1.5 years old, has never had an oil change. Recently, the van came to a sudden, permanent halt during its delivery rounds. The garage said that the damage to the engine is so severe that the engine must be replaced. The mechanic can install a rebuilt engine for a cost of $6,000.

The van was purchased for $30,000 and is being depreciated over 5 years, with a $5,000 residual value. The rebuilt engine should last the company 4 years under expected operating conditions, that is, about the same length of time the original engine would have run had it been maintained. The company's owner is upset about the expenditure and its potential impact on the company's operating results. He wants to capitalize the $6,000, and add two years to the original life of the van.

Is the accounting treatment of the new engine a "judgment call" that could go either way? What do you believe to be the correct accounting for this item?

Why is the way this expenditure is accounted for important? Who is harmed by incorrect accounting?