For most companies, non-current assets play a significant role in long-term survival and revenue generation. Companies utilize these assets to help in manufacturing products, attracting customers, creating value, etc. These are all necessary to increase profitability over several periods.
Non-current assets come as a result of capital expenditure. Companies incur these expenses to obtain benefits over multiple accounting periods. Most of these assets require large investments, which companies can source through either equity or debt finance. These may include resources, such as land, building, machinery, vehicles, electronics, furniture, etc.
Each type of asset has its own uses for companies. However, most of these assets come with a finite life. Therefore, companies must ensure that they extract any value from these assets before they expire. Similarly, companies must depreciate these assets due to the matching principle. Under this principle, companies must match any expenses to the incomes that they help generate.
One asset that does not require any depreciation is land. It is because land does not have a finite life, unlike most other assets. Therefore, companies can obtain benefits from their lands for an infinite amount of time. It may not apply in some cases, such as when extracting minerals and ores from the land. In that case, land may have a finite life.
Similarly, land improvements are another part of the land that is depreciable. Companies may incur land improvements in various circumstances. That is why it is crucial for companies to separate land from land improvements. Similarly, it is critical to understand what land improvements are and how they differ from the land.
What are Land Improvements?
Land improvements include any enhancements that companies make to a plot of land to make it more usable. These may consist of enhancements such as driveways, walkways, parking lots, landscaping, fences, drainages, irrigation systems, etc. Due to the nature of these installments, they have a finite life. Therefore, not depreciating them is not an option for companies, although they may be a part of the land.
Like other assets, land improvements have a finite life. For companies, however, the useful life may be more relevant than its overall life. Therefore, companies need to estimate the usage they will get from these improvements and charge depreciation accordingly. It is also necessary to keep land improvements separate from the actual cost of land to avoid any miscalculations.
Some improvements may also come with infinite life. In that case, companies can add the cost of these improvements to the total cost of land. Similarly, they do not have to depreciate it since these may have unlimited usage. However, land improvements mostly have limited usage. Therefore, they are often depreciable.
Companies must also ensure that land improvements satisfy the basic definition of capital expenditure. If an improvement or enhancement fails to meet the criteria, companies must expense it out and consider it revenue expenditure. It may include costs borne on leveling land or demolishing existing construction on it. These are not capitalizable expenses.
How to account for Land Improvement?
Accounting for land improvement is straightforward. As long as an improvement satisfies the criteria to qualify as a capital expenditure, companies must record it. Companies can use the following accounting entries to record land improvement.
| Account Name | Debit | Credit |
|---|---|---|
| Land improvement | XXX | |
| AP/Bank | XXX |
The above double entry is similar to recognizing any other asset that companies may purchase. However, if an improvement fails to meet the capital expenditure criteria, this treatment will not apply. Therefore, companies must expense improvement out instead. The treatment is as follows.
| Account Name | Debit | Credit |
|---|---|---|
| Revenue expenditure | XXX | |
| AP/Bank | XXX |
Another aspect of land improvement is the depreciation element. As mentioned, companies must depreciate land improvements like other assets. Although it is a part of the land, it does not mean that companies must not depreciate it. Once a company figures out the depreciation method for such improvements, they can use the following journal entries to record it.
| Account Name | Debit | Credit |
|---|---|---|
| Depreciation | XXX | |
| Accumulated depreciation | XXX |
The above treatment is similar to depreciation for any other asset. Depreciation is one of the reasons why companies differentiate between land and land improvements.
Example
A company, Lite Co., acquires land for $100,000. After a few years, Lite Co. performs landscaping on the site worth $10,000. Similarly, the company installs fences, which cost $10,000. All these transactions are through the bank. The company records these transactions as follows.
For land acquisition, the accounting entries are as follows.
| Account Name | Debit | Credit |
|---|---|---|
| Land | $100,000 | |
| Bank | $100,000 |
For the landscaping, the treatment is as follows.
| Account Name | Debit | Credit |
|---|---|---|
| Landscaping | $10,000 | |
| Bank | $10,000 |
Lastly, the journal entries for the installation of fences is as below.
| Account Name | Debit | Credit |
|---|---|---|
| Fences | $10,000 | |
| Bank | $10,000 |
Lite Co. cannot depreciate the $100,000 of land that it acquired. However, it must depreciate both the landscaping and fence improvements made to the land.
Conclusion
Land is a crucial asset for most companies. In accounting, land represents an asset with infinite life and is, therefore, not depreciable. However, land improvements usually have a finite life. Therefore, companies need to separate these and depreciate them according to their policies. Land improvements are any expenses companies incur on a plot of land to make it more usable.
