\"CA10-2 (Accounting for Self-Constructed Assets) Troopers Medical Labs, Inc., b
ID: 2457418 • Letter: #
Question
"CA10-2 (Accounting for Self-Constructed Assets) Troopers Medical Labs, Inc., began operations 5 years ago producing stetrics, a new type of instrument it hoped to sell to doctors, dentists, and hospitals. The demand for stetrics far exceeded initial expectations, and the company was unable to produce enough stetrics to meet demand. The company was manufacturing its product on equipment that it built at the start of its operations. To meet demand, more efficient equipment was needed. The company decided to design and build the equipment, because the equipment currently available on the market was unsuitable for producing stetrics. In 2014, a section of the plant was devoted to development of the new equipment and a special staff was hired. Within 6 months, a machine developed at a cost of $714,000 increased production dramatically and reduced labor costs substantially. Elated by the success of the new machine, the company built three more machines of the same type at a cost of $441,000 each. PROBLEMS SET B CONCEPTS FOR ANALYSIS
Instructions
(a) In general, what costs should be capitalized for self-constructed equipment?
(b) Discuss the propriety of including in the capitalized cost of self-constructed assets:
(1) The increase in overhead caused by the self-construction of fixed assets.
(2) A proportionate share of overhead on the same basis as that applied to goods manufactured for sale.
(c) Discuss the proper accounting treatment of the $273,000 ($714,000 2 $441,000) by which the cost of the first machine exceeded the cost of the subsequent machines. This additional cost should not be considered research and development costs.
Explanation / Answer
a) The cost of construction is $714000 for first machine and thereafter $441000 each for three machni.
In general the following cost should be capitalized:
1) Direct Material
2) Direct labour
3) Overhead Cost
4) Interest if money is borrowed
b) the answer is 2. As overhead cost are all the production cost incurred by the company for the asset except direct material and labour. It is foxed as well as variable cost..Allocating overhead to self-constructed assets enhances comparability with the cost of an equivalent purchased asset because the seller normally would include fixed overhead in its selling price.Construction related overhead is a relevant component of the asset’s cost and should be accounted for in the same way as regular products So it is better to allocate cost on the basis of goods manufactured. So one of the approch is to allocate indirect cost based on direct cost.
c) The whole amount will be capitalized because in constructing for the first time ofcourse the cost will be more as it is for first time. Than if the company is constructed again than as we have idea where we could save cost due to our previous experience.
However, it is inappropriate for a company to capitalize costs in excess of the asset's market value. If the overheads result in a total cost that is greater than the price of a commercially-produced asset, the excess overhead charges should be expensed and not capitalized.
So if we assume that $273000 is charged more than we can take it as a expense. But the better option is to capitalize.
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