In part 1 of this blog, we addressed the two funds – reserve fund and administrative fund – as well as how to differentiate between operational expenses vs capital expenditure.
This blog focuses on routine maintenance vs preventative maintenance and how these definitions can be quite confusing.
Routine vs preventative maintenance?
Some might prefer to classify maintenance works as “routine” (= administrative fund) vs “preventative” (= reserve fund). To complicate matters, both these maintenance approaches can be performed as an immediate but temporary repair to prevent further deterioration, restore an asset to its original condition, render it operational to a specified standard or replace a component at the end of its lifespan. As you can see, it makes it difficult to differentiate between an administrative fund expense and a reserve fund expenditure.
When a maintenance activity can be allocated to both categories – “routine” and “preventative/value-adding/life-extending”- it is justifiable to capitalise the associated cost. This decision ultimately lies with the trustees who must evaluate the situation case by case.
As a guideline, major capital maintenance can typically be characterised as involving major repairs, overhauls or replacements, occurring in variable intervals (not routine), being mandatory (not optional), requiring the services of a skilled contractor, incurring significant cost or being implemented as a project.
Community schemes might undertake improvements to increase an asset’s service life, enhance its functionality, reduce future operating costs or upgrade essential parts of the asset. Such improvements certainly fall into the domain of the reserve fund and can be planned for in advance. These can also arise unexpectedly, for example, when a contractor is called in to repair a leaking roof (= administrative fund) but after an evaluation determines that the leaky area is beyond repair and that the entire roof needs to be replaced (= reserve fund).
The 10-year maintenance plan is intended to provide organised guidelines to sustain the performance, mitigate further deterioration and achieve the full service life of the body corporate’s assets as well as ensuring that maintenance work is carried out before significant component failure occurs.
In other words, it focuses primarily on the preservation of existing assets. Therefore, it is essential to be aware of an asset’s lifespan or useful life, referring to the length of time that it serves its original purpose before needing to be replaced or substituted. In theory, every asset has its own useful life which can be influenced by a range of factors such as material grade, build quality, wear and tear, environmental effects but it can also be affected by new compliance and safety regulations, or simply by becoming technically or commercially obsolete.
Bodies corporate can decide to extend an asset’s lifespan by performing maintenance that utilises better materials or improves its design. It is important to review the expenditure carefully so that it can be allocated correctly.
To make the right decision, one must consider the asset’s value, the scope of work required, the intended result as well as its impact on the asset’s value, depreciation and equity return.
Applying the correct cost classification is not always a one-size-fits-all undertaking but it is worthwhile considering it thoroughly as it will go a long way towards stabilising the body corporate’s financial situation in the long run.