Jay Manufacturing Inc., began operations five years ago producing the probo, a n

Question

Jay Manufacturing Inc., began operations five years ago producing the probo, a new type of instrument it hoped to sell to doctors, dentists, and hospitals. The demand for probos far exceeded initial expectations, and the company was unable to produce enough probos to meet demand. Jay was manufacturing probos on equipment it built at the start of its operations, but it needed more efficient equipment to meet demand. Company management decided to design and build the equipment, because no equipment currently available on the market was suitable for producing probos.

In 2014, a section of the plant was devoted to development of the new equipment and a special staff of personnel was hired. With six months, a machine was developed at a cost of $170,000 that increased production and reduced labor cost substantially. Sparked by the success of the new machine, the company built three more machines of the same type at a cost of $80,000 each.

A. In addition to satisfying a need that outsiders cannot meet within the desired time, what other reasons might cause a firm to construct fixed assets for its own use?

B. In general, what costs should be capitalized for self-constructed asset?

C. Discuss the appropriateness (give pros and cons) of including these charges in the capitalized cost of self-constructed assets:

i. The increase in overhead caused by the self-construction of fixed assets

ii. A proportionate share of overhead on the same basis as that applied to goods manufactured for sale (consider whether the comapny is at full capacity)

D. Discuss the proper accounting treatment of the $90,000 ($170,000-$80,000) by which the cost of the first machine exceeded the cost of the subsequent machines.

Explanation / Answer

A. As mentioned in the question, there is a need of constructing machine for its own own use becoause of following :-

a) Firstly, there is no availability of such machine in the market and to cater demand of product, the mechine has to be constructed itself.

b) Firm has the additional capacity to construct the machine for its own use.

B)

Increase in overhead cost : Overheads which are specifically meant for constructing the assets should be capitalised for machine cost. General increase in overhead should be analysed in detail, as loading of it will increase the cost of Asset and will may revert back the decision of making products from this.

If company is operating at full level : If company is oparating at full capacity then also, share of overhead specifically applied on construction of fixed assets should be capitalised. Other basis may increasse or decrease the cost of the asset.

D)

Each machine constructed is an seperate asset so, cost computed on each machine is capitalised for that machine. So, first machine shoould be capitalised at 170000$, provided the costs are computed on the basis of best judgement and prevailing accounting standards.

Next machines are capitalised at 80000$, for the same reason

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