"Renewals" include the cost of extending the life period of some capital asset alreadY existing thru a process of extensive repairs; renewals may gener ally be termed extraordinary repairs. Minor renew als are generally included under the heading "repairs." The term "repairs" embraces expenses incurred in replacing any part of a unit the replacing of which is made necessary thru wear and tear or thru ac cident. Repairs are distinguished from replacements in that replacements are charged to the capital ac count and the value of the article displaced is credited to that account. Repairs are strictly revenue items and are not to be charged to the capital account, but should be charged to operating expenses for the reason that the replacement or renewal is a minor one and does not cause a substantial change of identity in the unit of equipment upon which the expenditure has been made.
5. Capitalization of additional is usually little difficulty in determining whether charges for additional equipment should be capitalized or not. However, problems sometimes arise in the case of the purchase of the entire assets of another or ganization. Let us assume that company "A" pur chases the assets of company "B" at a flat price and that before purchasing these assets company "A" has carefully considered the value of each of them and has determined the purchase price accordingly. It may happen that with the equipment are certain units of no use to company "A" but which the company is obliged to buy in order to secure the remainder of the equipment. It would be proper for company "A" to value the assets acquired at the purchase price, treating the undesirable units as scrap material. If, on the other hand, a mistake was made in the first valuation of . the assets, and upon revaluation it is discovered that the equipment purchased will require considerable expense to prepare it for operation, it is evident that the capital account should be charged with only the cost price of the units acquired. The loss due to the mistake in valuation becomes a proper charge against surplus account, because it is not al lowable to capitalize mistakes in judgment. How ever, if it was known at the time of purchase that these amounts would' have to be expended, the situation would be different and the expenditures on the pur chased equipment would then become capital charges. The repairs which company "A" must make on any equipment purchased in this manner may therefore be capital or revenue expenditure depending upon the conditions under which the units were purchased.
Occasionally, in reorganizations of manufacturing and trading concerns a new manager takes over a much neglected plant. The old management has failed to provide properly for depreciation and has indulged in the pernicious economy of neglecting the necessary repairs and renewals which should have been made on the equipment. The new management might very properly object to charging in the revenue account the cost of repairs and renewals on wornout equipment, and it might claim also that such repairs should be capitalized and not charged against the revenue account. This procedure would, of course, be improper and would result in a false profit being shown, but inasmuch as the expenditures should have been made by the previous management, the amount necessary to bring the equipment into proper operat ing condition should be charged to surplus account. If there is no surplus account against which the items can be charged, the expense of making repairs can be carried as a deferred charge in an appropriately ear marked account on the balance sheet and be written against surplus in succeeding years.
6. Adjustment of inventory valuations on change of not directly connected• with the property account, it may be noted in this connec tion that the new management may also object to the inventory valuation of merchandise carried on the books by the former management. It frequently hap pens that the old management in order to make a good showing may have appreciated the inventory, or it may have carried at inflated values merchandise that is shopworn, out of fashion or not in proper con dition to sell. If these conditions obtain and the mer chandise is overvalued, the adjustment in the accounts should be made thru surplus at the beginning of the period and not thru the current revenue ac count. It is only fair to the new management to see that at the commencement of its operations all equip ment shall be in good operating condition and the merchandise inventory properly valued.
7. When shrinkage in the value of capital assets is to be ignored.—Capital assets, however, may de crease in value without affecting revenue. For ex ample, a shrinkage in the value of assets may occur owing to causes outside of the ordinary operations of the business. Therefore, as long as these assets are not disposed of, such shrinkage can only be an esti mated item and may properly be ignored in the ac counts.