Are Land Improvements Depreciable?
Land improvement is the process by which the company increases the land usable by enhancing the plot of land.
Different from land, the land improvement may be able to depreciate if we can define its useful life.
The land that is under company ownership is not supposed to depreciate as its value will remain forever. There is no defined useful life for land. However, the land improvement maybe lasts for a certain period only. It depends on the nature of improvement.
First, we have to look at the nature of land improvement if it meets the requirement to be capitalized as fixed assets. Not all improvements will be classified as fixed assets, some of them may be recorded as expenses as well.
The land improvement that meets the fixed assets requirement should be able to provide future economic for the company for more than 12 months. It does not make sense to capitalize them as fixed assets and depreciate them within the same year. It should be recorded as an expense in the first place. The amount of capitalization must comply with the company fixed assets policy as well. It will depend on the policy of each company. Some companies design policies to capitalize only the high amount to prevent unnecessary work for the small fixed assets.
Second, the land improvement will increase the land usable. As the name suggests, it is the improvement of land. The assets spend have to increase the land value during the time. It is not the stand-alone fixed assets that have no impact on the land value and usage.
Third, we have to analyze the land improvement has defined useful life. Some land improvement’s useful life cannot be measured reliably. The company has to calculate the useful life of land improvement very carefully. It is the useful life of the improvement only. At the end of its useful life, the land will reverse its usable to the original state.
Land Improvement Depreciation
The depreciation of land improvement is not different from other fixed assets class. It depends on the depreciable cost and useful life.
When the company is able to analyze the nature of land improvement and it meets the criteria above, it will be recorded as fixed assets on the balance sheet.
At the same time, the company should start to depreciate the land improvement.
Depreciation per year = Land improvement depreciable amount / useful life
Land improvement depreciable amount is the total amount that a company spends to improve the land. It can be the cost of material and labor which include in the construction of the assets. However, we have to ensure that the construction is not the building that has to record in another class of fixed assets.
Journal Entry
When the land improvement meets the requirements to be capitalized as fixed assets, the company has to record them on the financial statement.
The journal entry is debiting Fixed Assets – Land Improvement and credit cash or accounts payable.
| Account | Debit | Credit |
|---|---|---|
| Fixed Assets – Land Improvement | $$$ | |
| Cash/Accounts Payable | $$$ |
The transaction will increase the fixed assets balance on the balance sheet. It also reduces the cash balance or increases the company’s obligation to pay in the future.
After calculation of depreciation expense, the company has to record it into the financial statement as well.
The journal entry is debiting depreciation expense and credit accumulated depreciation.
| Account | Debit | Credit |
|---|---|---|
| Depreciation Expense | $$$ | |
| Accumulated Depreciation – Land Improvement | $$$ |
The entry will increase the depreciation expense on the income statement. At the same time, it will increase accumulated depreciation which will reduce the fixed assets net balance.
Example
Company ABC owns a plot of land which is recorded on the financial statement. During the year, the company decided to build a drainage system to prevent floods during the rainy season. The cost of construction is $ 50,000 and it allows the company to use the land all year around. Based on the expert, the system is expected to last for 10 years. Please calculate the depreciable amount of land improvement and record the journal entry.
This is the land improvement, it helps to increase the land usability even during the rainy season. The company should capitalize it as the fixed assets on the balance sheet.
The journal entry is debiting fixed assets – land improvement $ 50,000 and credit cash $ 50,000.
| Account | Debit | Credit |
|---|---|---|
| Fixed Assets – Land Improvement | 50,000 | |
| Cash | 50,000 |
In the same period, company needs to start depreciation as well.
Depreciation expense = 50,000 / 10 years = $ 5,000 per year
They need to record the depreciation expense.
The journal entry is debiting depreciation expense $ 5,000 and credit accumulated depreciation $ 5,000.
| Account | Debit | Credit |
|---|---|---|
| Depreciation Expense | 5,000 | |
| Accumulated Depreciation – Land Improvement | 5,000 |
