Renovation of a fixed asset - how should it be accounted for?
The use of fixed assets in the company causes their consumption, therefore entrepreneurs incur various types of expenses aimed at maintaining, extending or changing their functionality. Tax regulations require a precise determination of the nature of this type of economic event, as it determines the method of recognizing expenses related to assets in the company's accounting records. They can be classified into two categories - the first is the renovation of the fixed asset and the second is its improvement. The first of them will be discussed in detail later in the article.
What is a repair of a fixed asset?
The main cause of problems in qualifying the expenses incurred in connection with the fixed assets used in the company is the fact that the term "renovation" has not been defined in the income tax laws. In a situation where the expenditure relates to construction works, the definition of renovation set out in Art. 3 point 8 of the Construction Law Act of 7 July 1994, in accordance with the position of the Director of the Tax Chamber in Warsaw presented in the individual ruling of 8 March 2013 (reference number IPPB1 / 415-109 / 13-2 / JB). We read in the interpretation that (...) in relation to renovation, the definition formulated in the provisions of the construction law should be used. Pursuant to Art. 3 point 8 of the Act of 7 July 1994 - Construction Law (...) a renovation is the performance of construction works in an existing building object consisting in the restoration of the original technical and functional condition of a fixed asset, and not constituting current maintenance, while the use of construction products is allowed other than those used in the original state.
But what if the fixed assets are assets other than construction works? In such a case, the repair of a fixed asset is considered to be activities aimed at restoring their original technical and functional condition, including the replacement of worn-out parts, but not changing the nature and functions of these fixed assets.
Examples of renovation are: replacement of wooden windows with plastic ones, replacement of electrical installation, insulation of external walls of the facade, repair and maintenance of machines, replacement of their worn-out parts.
Fixed asset repair and improvement
At this point, it should be mentioned that it is extremely important to recognize when an improvement takes place and when a repair of a fixed asset takes place. This is important in relation to the method of accounting for the expenditure incurred in connection with a given asset in the company's accounting.
Fixed assets are considered to be improved when the sum of expenses incurred for their reconstruction, extension, reconstruction, adaptation or modernization in a given tax year exceeds PLN 3,500, and these expenses increase the value in use in relation to the value on the day of accepting the fixed assets for use. The increase in the value in use of a fixed asset is measured in particular by the period of use, production capacity, quality of products obtained with the help of improved fixed assets and the costs of their operation. Such an understanding of the improvement of the company's assets results from Art. 22 g of paragraph 1. 17 of the Personal Income Tax Act (hereinafter: the PIT Act; Article 16g (13) of the Corporate Income Tax Act - hereinafter the CIT Act).
The difference between an upgrade and a renovation is mainly that the former is not intended to restore the original, lost functional features, but to increase the value in use of an asset. Examples of improvements are: expenditure on a machine, which will increase the productive forces or the quality of manufactured products, or expenditure on adaptation of the premises, aimed at changing the nature of its use and purpose.
It should be remembered that the expenses related to the improvement of the fixed asset increase its initial value and are classified as tax deductible costs through depreciation write-offs.
Fixed asset repair - recognition in the KPiR
When expenses for the repair of a fixed asset are incurred during the operation of a given asset, they are recognized directly as tax deductible costs, regardless of their value. Taxpayers who keep a tax book of revenues and expenditures, expenditure on a fixed asset classified as renovation should record on the date it is incurred, i.e. on the date of issuing an invoice (bill) or other evidence constituting the basis for recognizing the cost.
The entrepreneur runs a business in a building with windows in a very bad technical condition. He decided to replace them with new ones with better technical parameters. The window openings did not change during the replacement. To confirm the cost, the entrepreneur received an invoice issued on February 2, 2014, for the amount of PLN 18 thousand. zloty. He decided to classify the expenses incurred as a renovation of a fixed asset, due to the fact that the replacement of windows did not increase the utility value of the building (in relation to the value on the date of commissioning). Therefore, he included the aforementioned expense directly as costs on the invoice issue date, i.e. on July 2, 2017.
Renovation of the fixed asset before it is entered in the records
The record of expenditure on the repair of a fixed asset will look different if it is carried out before the given asset is entered into the register of fixed assets of the enterprise.
Pursuant to the provisions of the Income Tax Acts, a taxpayer cannot recognize an asset that cannot be used as a fixed asset. However, in accordance with the provisions contained in Art. 22 g of paragraph 1. 3 of the PIT Act (Article 16g (3) of the CIT Act), in a situation where, before being brought into the company, it requires adaptation to be used for business purposes (e.g. renovation), the related expenses increase its initial value. Confirmation of this position can be found in the judgment of the Supreme Administrative Court of May 31, 2011 (file reference number II FSK 25/10). In the considered facts, the company purchased real estate to be used in business activities. Before putting the facility into service, the company carried out a renovation of the roof, window openings filled with glass blocks (glass blocks), social rooms and electrical installations, replaced windows, doors and entrance gates, repainted the facility and repaired the floor in the hall. The court found that: (...) costs related to the overhaul of a fixed asset as expenses related to bringing this asset to use in the company's business are costs related to the purchase of a fixed asset and justify them to be included in the initial value of a fixed asset, and thus to be successively including costs (Article 15 (6) of the CIT Act).
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Fixed asset repair and depreciation
Repairing a fixed asset may raise doubts as to the need to suspend depreciation of the renovated asset due to its temporary exclusion from use. Pursuant to Art. 22 h of paragraph 1. point 1 of the PIT Act (Article 16h (1) (1) of the CIT Act), depreciation write-offs should be made from the first month following the month in which the asset was entered into the register, until the end of the month in which the sum of depreciation write-offs is equated with its initial value or in which it was put into liquidation, disposed of or found to be deficient.
The necessity to suspend depreciation is mentioned in Art. 22c point 5 of the PIT Act (Article 16c point 5 of the CIT Act). According to its content, assets that are not used due to:
suspension of activities under the provisions on freedom of economic activity, or
cessation of the activity in which they were used.
As can be seen among the above-mentioned situation, there is no exclusion from use as a result of the renovation of the fixed asset, therefore it is not a reason to stop making depreciation write-offs.