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Maintenance can be a significant activity for reporting entities with capital projects. Maintenance programs may involve the use of internal resources or third-party maintenance providers. Third-party agreements may be stand-alone service agreements or embedded in a lease. All routine maintenance should be expensed as incurred. PPE 1.4 focuses on the accounting for major maintenance activities, including specific considerations when the services are provided through a long-term service agreement or lease.

1.4.1 Accounting for major maintenance

The AICPA Audit and Accounting Guide for Airlines (the Airline Guide) provides the principal source of guidance on accounting for major maintenance activities. A limited portion of this guidance was codified in ASC 908, Airlines.
The term “overhaul” is frequently used to describe the process of inspecting and maintaining an asset. Overhaul costs typically include replacement of parts and major repairs and maintenance. The accounting for the replacement of parts or components is discussed in PPE 1.2.1.4. The treatment of major repairs and maintenance costs will depend on whether such costs meet the specified criteria for recognition as an asset. The costs of “day-to-day servicing” of an asset do not meet the FASB Concepts Statement No. 6, Elements of Financial Statements, asset recognition criteria and do not qualify as major maintenance. However, major repair and maintenance programs carried out as part of a periodic inspection and overhaul and that result in future economic benefits beyond those initially expected may qualify for recognition as an asset. The dry-docking of a ship would be an example of such an event.
There are three acceptable methods of accounting for major maintenance, as highlighted in Figure PPE 1-2. Although based on the Airline Guide, the SEC staff has indicated that the guidance should be applied by analogy to all major maintenance activities.
Figure PPE 1-2
Accounting for major maintenance activities
Method
Guidance
Direct expense
(ASC 908-720-25-3)
Overhauls associated with large fleets are relatively constant from period to period, thus most carriers recognize the cost of overhauls as expense as they are incurred.
The actual cost of each overhaul is capitalized and amortized to the next overhaul.
Built-in overhaul
(ASC 908-360-30-2 and ASC 908-360-35-5)
When overhaul costs are included or combined with other costs, a reporting entity would segregate costs into components that (1) are depreciated over the useful life of the asset and (2) require overhaul at periodic intervals. The cost of the initial overhaul is capitalized and amortized to the next overhaul, at which time the process is repeated.
To demonstrate the built-in overhaul method, consider a blast furnace with a lining that needs to be replaced every five years. No provision can be made for replacement of the furnace lining before the reporting entity incurs the expenditure; until that time, the reporting entity has no present obligation because it does not have to replace the lining. For example, it could avoid the obligation by decommissioning the blast furnace. Although no provision can be built up over the five years before the expenditure is incurred, the blast furnace lining should be segregated as a separate component upon acquisition and depreciated over a five year period, rather than over the useful life of the furnace itself. When the expenditure is incurred to replace the lining, it will be capitalized as a component of the cost of the furnace and will be separately depreciated over the period until it is next replaced (i.e., five years). The cost and depreciation attributed to the original blast furnace lining should be removed once the cost of the new blast furnace lining has been capitalized, because the original asset would be disposed of when replaced with the new lining.
Major maintenance costs cannot be accrued in advance of the maintenance taking place. The Airline Guide provides additional information on application of the three acceptable methods.

AICPA Audit and Accounting Guide for Airlines

Paragraph 4.113
The cost of line maintenance and other routine repairs, whether performed by the airline or outsourced to a third-party provider, is expensed as incurred. However, there are three acceptable methods of accounting for planned major maintenance activities performed under established programs for regulatory compliance related to different fleet types and for engines, airframes, or major components of the same aircraft type. FASB ASC 908-360-25-2 states that air carriers shall adopt an accounting method that recognizes overhaul expenses in the appropriate period. This may result in different methods for different aircraft, as well as different methods of airframe overhauls and engine overhauls. These methods are described in the following paragraphs.
Paragraph 4.114
Expense as incurred method. Under this method, all maintenance costs are expensed in the period incurred because maintenance activities do not represent separately identifiable assets or property units in and of themselves; rather, they serve only to restore assets to their original operating condition.
Paragraph 4.115
Deferral method. Under this method, the actual cost of each planned major maintenance activity is capitalized and amortized to expense in a systematic and rational manner over the estimated period until the next planned major maintenance activity.
Paragraph 4.116
Built-in overhaul method. Under this method, costs of activities that restore the service potential of airframes and engines are considered a component of the asset. This method cannot be applied to leased aircraft. The cost of airframes and engines (upon which the planned major maintenance activity is performed) is segregated into those costs that are to be depreciated over the expected useful life of the airframes and engines and those that represent the estimated cost of the next planned major maintenance activity. Thus, the estimated cost of the first planned major maintenance activity is separated from the cost of the remainder of the airframes and engines and amortized to the date of the initial planned major maintenance activity. The cost of that first planned major maintenance activity is then capitalized and amortized to the next occurrence of the planned major maintenance activity, at which time the process is repeated.
Paragraph 4.117
FinREC believes the expense as incurred method is preferable to all other methods of accounting for maintenance activities.

As noted in paragraph 4.117, FinREC believes that the expense as incurred method is preferable, although any of the three methods may generally be used. The method used to recognize major maintenance expense is an accounting policy election that should be applied consistently for all similar projects.
The deferral or built-in overhaul methods of accounting for major maintenance cannot be used when the group or composite method of depreciation is used. Under the group or composite method of depreciation, depreciation is applied to a pool of assets based on the average useful life of the assets. The application of the deferral or built-in overhaul method of accounting for major maintenance requires separately accounting for maintenance costs associated with component assets. Once the group or composite method of depreciation is applied, individual assets lose their individual identity and the pool is in effect one component. Therefore, any amounts related to major maintenance would need to be accounted for using the direct expense method.

1.4.2 Long-term service agreements

Concurrent with the construction or acquisition of assets, reporting entities may enter into long-term service agreements with third-party providers to perform major maintenance. These agreements usually involve major maintenance services, including refurbishment or replacement of capital parts, as well as routine maintenance activities. Generally, payments under a long-term service agreement (LTSA) are made on a recurring basis and maintenance is performed at scheduled dates in accordance with an agreed-upon milestone schedule.
LTSAs are common in many industries and typically pass the service provider’s cost of parts, equipment, and specified costs to the customer, or otherwise share the cost risk between the service provider and the service provider’s customer. This feature in an LTSA is a funding or cash flow mechanism and does not drive the timing of expense recognition. Instead, the reporting entity’s major maintenance accounting should be determined based on its overall policy for similar capital projects. Some long-term service agreements are based on a pricing mechanism that fully transfers the cost risk to the service provider. The accounting for this type of contract may vary from the general model. Accounting for fixed price LTSAs is discussed in PPE 1.4.2.1; accounting for variable priced LTSAs is discussed in PPE 1.4.2.2.

1.4.2.1 Accounting for fixed-price long-term service agreements

Stand-alone LTSAs usually involve pass-through of certain specific costs to the owner of the capital project or otherwise share price risk between the parties to the agreement. Conversely, some LTSAs have a fixed price for the duration of the contract and may transfer certain risks of providing maintenance services, including cost risk, to the service provider.
The Airline Guide discusses agreements in the airline industry (known as power-by-the-hour (PBTH) contracts). Under PBTH contracts, airlines generally pay the service provider a fixed amount per flight hour in exchange for required maintenance and repairs under the predefined maintenance program. Although the type of contract is specific to the airline industry, the agreements, and the related issues, can be similar to those encountered by companies in other industries. Therefore, in the absence of authoritative guidance, the framework set forth in the Airline Guide can be helpful in evaluating the appropriate accounting for these and similar arrangements in other industries. Paragraph 4.123 of the Airline Guide addresses PBTH agreements.

Excerpt from AICPA Audit and Accounting Guide for Airlines
Paragraph 4.123

FinREC believes the issues relating to PBTH contracts and other similar arrangements with independent maintenance and repair providers include determining whether risk has been transferred to the service provider. The risk transfer criteria discussed in this section provide a framework for determining whether there is a transfer of risk. If the contract transfers risk, FinREC believes the airline should recognize maintenance expense in accordance with the PBTH contract, as opposed to following its maintenance accounting policy. In these situations, FinREC believes there is a presumption that the expense should be recognized at a level rate per hour during the minimum, noncancelable term of the PBTH agreement. That presumption could be overcome by evidence that the level of service effort varies over time, consistent with the variations in the payment pattern under the PBTH contract.


The key criteria in evaluating whether risk has transferred are discussed in paragraph 4.125 of the Airline Guide as summarized in Figure PPE 1-3.
Figure PPE 1-3
Transfer of risk criteria
Criterion
Guidance
True-ups
he service provider absorbing substantially all of the variability of the cost of maintenance may transfer risk to the service provider.
A contract that provides for true-up payments to cover actual costs incurred by the service provider would not result in risk transfer.
Contract adjustment provisions
Contracts with adjustments for a change in scope may transfer risk if they are not merely true-up adjustments for the service provider’s actual costs.
Annual or periodic inflation adjustments are also permitted, as well as increases tied to certain performance criteria, if adjustments tied to performance are capped or otherwise limited.
Termination provisions
Buy-out provisions that provide for cost recovery on termination would not transfer risk.
Termination provisions need to be substantive enough to prevent either party from exiting at their discretion or risk is not transferred.
If the reporting entity concludes that risk is transferred to the service provider, the maintenance costs should be accounted for in accordance with the terms of the agreement, rather than based on the reporting entity’s normal policy for maintenance. In developing an expense recognition policy for this type of contract, there is a presumption that expense should be recognized on a level rate based on usage; however, this presumption may be overcome if there is evidence that the level of service effort varies over time and that changes in expense are reflective of changes in service. Changes in contractual rates based on an index, such as Consumer Price Index, or rates that cannot be reliably determined at the start of the contract would not be leveled, except to the extent there is a specified minimum increase.
We believe the PBTH model discussed in the Airline Guide is reflective of the underlying economics of a fixed-price maintenance agreement and that it is appropriate for companies, absent other applicable authoritative literature, to apply it in evaluating and accounting for fixed price LTSAs.
Example PPE 1-6 illustrates the accounting for a fixed price long-term service agreement that includes capital spares.
EXAMPLE PPE 1-6
Accounting for a fixed price long-term service agreement that includes capital spares
PPE Corp has a contract with a maintenance provider to perform major maintenance inspections after certain hour intervals on a dual-armed robot used in PPE Corp’s production facility. The contract requires that PPE Corp purchase a portfolio of capital spares to be kept “on the shelf” in storage during the period of the contract for use during major maintenance. The capital spare parts are paid for by PPE Corp at the start of the contract.
The capital spares may not be resold or used for any purpose other than major maintenance activities on PPE Corp’s robot. PPE Corp will have title to the parts when purchased; however, title to any remaining capital spares in storage when the maintenance contract expires will transfer to the maintenance provider.
How should PPE Corp account for the spare parts?
Analysis
In this example, the contract is a fixed-price long-term service agreement that transfers cost risk to the maintenance provider. The initial purchase will provide PPE Corp with capital spares on hand for use in the major maintenance activities; however, PPE Corp is not entitled to retain the capital spares at the expiration of the contract. As such, there is a presumption that expense should be recognized on a level rate based on usage over the term of the contract, as the services provided (and related effort level) do not change over time. The payment for the capital spares represents an additional service payment and should be amortized over the term of the contract.

1.4.2.2 Accounting for variable price long-term service agreements

Variable price LTSAs typically share the cost risk associated with the service contract between the service provider and the reporting entity. A reporting entity should evaluate the LTSA and determine whether the contract meets the risk transfer criteria summarized in Figure PPE 1-3. Paragraph 4.124 of the Airline Guide addresses PBTH contracts that do not meet the risk transfer criteria.

AICPA Audit and Accounting Guide for Airlines

If a contract does not meet the risk transfer criteria, FinREC believes the payments made under the contract should be recorded as a deposit or prepaid expense to the extent recoverable through future maintenance activities. When the underlying maintenance event occurs, it would be accounted for as maintenance expense or capitalized in accordance with the airline's maintenance accounting policy. Any nonrefundable amounts that are not probable of being used to fund future maintenance activities would be recognized as expense. If the cost per event is not specifically determined from the contract, the airline would record maintenance expense based on the best estimate of the cost of the underlying maintenance services. The amount of maintenance expense recorded would need to be supported by evidential matter. Such support could include prior costs for similar maintenance activities, documentation from a maintenance provider or other third parties, or both. Nonroutine maintenance, including payments under contracts for FOD or other out of scope work, would also be expensed as it is incurred.

An LTSA often includes multiple price components, such as a fixed monthly fee, variable monthly fees, and milestone payments based on service hours of the asset being maintained. These components typically cover major service events and monthly routine services to monitor and manage the performance of the covered equipment. The service provider may itemize the costs into major categories, such as capital parts, consumable parts, field services, component repair services, and other contractual services. In some circumstances, it may be difficult to determine the cost of the different services and the appropriate allocation between routine and major maintenance. To properly account for maintenance services, a reporting entity should implement policies to understand how the payments relate to the products and services provided under the LTSA. This information should be used to classify the costs between routine and major maintenance activities. Prior experience with similar agreements may also provide information to help allocate costs between routine and major maintenance services.
Amounts related to routine maintenance should be expensed as incurred. Amounts related to major maintenance should be recorded in accordance with the reporting entity’s policy for major maintenance. Any differences between the amount expensed and paid should be reflected on the balance sheet either as an asset or liability as appropriate.
Example PPE 1-7 illustrates the accounting for a variable price long-term service agreement.
EXAMPLE PPE 1-7
Accounting for a variable price long-term service agreement
PPE Corp enters into a 15-year long-term service agreement (LTSA) with Service Provider Corp for planned maintenance services on their automated manufacturing lines within their production facility. The LTSA calls for the following:
  • Fixed monthly fee of $50,000
  • Variable monthly fee based on run hours (estimated as $100,000 per month)
  • Payments of $5,000,000 at various milestones based on run hours
PPE Corp determines that the fixed monthly fee is entirely related to routine maintenance based on discussion with and review of documentation provided by Service Provider Corp. PPE Corp also determines that the variable monthly fee includes an expense component related to routine maintenance of $25,000 and capital components (including labor and parts not controlled by PPE Corp) of $75,000. PPE Corp has concluded that the milestone payments are capital in nature and relate solely to major maintenance activities.
How should PPE Corp account for the payments under the LTSA?
Analysis
PPE Corp should expense the monthly fee and the expense portion of the variable fee as incurred because they were determined to be related to routine maintenance. PPE Corp can choose one of three methods to account for the capital component of the variable monthly fee and the milestone payments:
  • Direct expense
PPE Corp would establish a prepaid asset as the capital portion of the variable monthly fee and milestone payments are made and would recognize the expense when the major maintenance is performed.
  • Deferral method
PPE Corp would record an asset as the capital portion of the variable monthly fee and milestone payments are made. PPE Corp would begin to amortize the amounts after the first major maintenance event occurs and over the expected period until the next major maintenance.
  • Built-in overhaul method
PPE Corp would separately depreciate the cost of the overhaul—which was separated from the initial purchase price of the asset—to the date of the initial overhaul. The accounting for the payments under the LTSA would then follow the deferral method.
Under all three scenarios, PPE Corp should consider whether it is receiving any maintenance services in advance of payments made or whether any amounts represent prepayments for future services. For example, this may arise if the milestone payments are not reflective of the underlying cost of the maintenance provided throughout the payment date (may be higher or lower). In such cases, PPE Corp should estimate the actual amount of expense and record a prepaid or an accrual for the difference from its actual payments.

1.4.3 Maintenance included in lease arrangements

Many agreements to obtain access to machinery or other equipment are accounted for as leases and implicitly include operations and maintenance services. Maintenance services are an executory cost of the lease or are considered “other services,” which are generally nonlease components. In either case, the maintenance services are not part of the minimum lease payments and would not be part of the lease accounting, unless the reporting entity elects the practical expedient to combine lease and nonlease components (see LG 2.4.5.1 for further details). Instead, a lessee should follow the appropriate LTSA model in determining how to recognize expense for the maintenance services. In many cases, these agreements will meet the risk-transfer criteria and will be subject to the fixed-price recognition model discussed in PPE 1.4.2.1. This recognition pattern will frequently be similar to the pattern of lease expense recognition under an operating lease.

1.4.3.1 Maintenance deposits under lease arrangements

ASC 840-10-25-39B and ASC 842-20-55-8 specify that a maintenance deposit paid by a lessee under an arrangement accounted for as a lease should be accounted for as a deposit asset when the deposit will be refunded only if the lessee performs certain specified maintenance activities.
In some cases, these prepayments for maintenance may be termed in different ways, including “maintenance reserves” or “supplemental rent.” This guidance applies to all types of deposits that are substantively and contractually related to the maintenance of the leased asset. Maintenance deposits should be accounted for as deposit assets. If the lessee determines that an amount on deposit is not probable of being returned, it should be recognized as additional expense.
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