Accounting for Renovation Costs
Renovation costs are the expenses that company spends to renovate the building on a regular basis or due to a specific reason.
The building requires normal renovation to change some parts of its look. It does not suppose to increase the building’s useful life or future economic benefit.
The renovation happens on the old building which is already complete and being used by the owners. The purpose of the renovation is to change the look of the building and create branding, and the outside modification.
The renovation also happens due to a specific reason such as improving the building which increases the value or useful life of the building.
The cost of the renovation includes the material, labor, and service provided by the contractors.
If the renovation increases the building’s useful life or the future economic benefit, it will record as a building improvement which is the classification of the fixed asset.
The term renovation and building improvement are used interchangeably. We should analyze the nature of renovation or building improvement rather than the term use.
The renovation includes the following items:
- Repaint
- Change Window or Door
- Replace Cabinet
- Replacing tiles or flooring
- Install new light system
Journal Entry for Renovation Cost
Renovation is the cost that company spends to modify the building and it will not increase the building’s useful life. So it will be recorded as the operating expense.
The journal entry is debiting renovation expenses and credit accounts payable.
| Account | Debit | Credit |
|---|---|---|
| Renovation Expense | 000 | |
| Accounts Payable | 000 |
The transaction will increase the operating expense on the income statement and the accounts payable on the balance sheet.
If the building renovation increases the useful life or the benefit of building, for sure it will be recorded as the building improvement which is the fixed assets.
The journal entry is debiting building improvement and credit accounts payable.
| Account | Debit | Credit |
|---|---|---|
| Building Improvement | $$$ | |
| Accounts Payable | $$$ |
The journal entry increases the fixed assets on the balance sheet and accounts payable.
At the same time, company has to record the depreciation of the building improvement. The deprecation depends on the total cost spent and estimated useful life.
Depreciation Expense per year = Total cost of building improvement / useful life
Example
Company ABC owns a building which is used as the showroom to present the new products to the customers. During the launch of new product, company decides to renovate the showroom which includes adding the logo of the new product and the surrounding theme.
The total cost of renovation is $ 5,000. Please prepare an accounting record for this renovation.
This is the renovation which is made to rebrand the showroom which will not add any value to the building. The branding will be renewed every release of a new product. The building is already being used even without the renovation.
The cost of renovation should be recorded as the expense on the income statement. The journal entry is debiting renovation expense $ 5,000 and credit accounts payable $ 5,000.
| Account | Debit | Credit |
|---|---|---|
| Renovation Expense | 5,000 | |
| Accounts Payable | 5,000 |
Example 2
Company just purchase a new building that cost $ 500,000. Due to the floor condition, it is required to renew before using it as the office. Management decide to spend $ 50,000 to renovate the floor which expects to last for 5 years.
Please prepare an accounting record for the renovation.
Based on this condition, building requires changing the floor so it is ready to use. The floor renovation adds value to the building and it lasts for 5 years. So this renovation should be capitalized as the fixed assets on the balance sheet.
It should be capitalized as a separate fixed asset from the building as it may have different useful life from the building.
The journal entry is debiting building improvement and credit accounts payable.
| Account | Debit | Credit |
|---|---|---|
| Building Improvement | 50,000 | |
| Accounts Payable | 50,000 |