In: Accounting
I found the discussion of self constructed assets to be interesting. These would be assets that the company itself builds instead of buys. The book talks about the difficulties in establishing the cost of the asset. How much of the company's overhead should be allocated to the project? How should interest incurred during construction be handled? There are a few options/opinions about how to handle overhead, which do you find to be best?
Self constructed assets, its costing and what is to be capitalized (Overview about total costs and Specifics about overheads and interest costs)
-In order to specifically identify the costs related to an asset
the company is developing in-house, the company must make a system
like making the construction a SPECIAL PROJECT to identify the
costs.
-All costs like employee hours etc. must be specifically marked for
the said project for identification purpose.
-Overhead costs - Overhead costs must be allocated to the project
using a standard systematic basis. A standard and justifiable
methodology must be developed and used without fail. Overheads cost
would include costs like salaries of managers who are responsible
for multiple projects and materials like glue, grease,oil, nails
that are purchased in bulk for all the projects.
There are various methods available to allocate the overhead
cost
-it can be allocated on the basis of machine hours
-It can be allocated on the basis of labor hours
-It can be allocated on the basis of labor cost (when labor rates
are different, the allocation will be different as compared to
labor hours)
-It can be allocated on the basis of activity drivers. (ABC
Costing)
ABC costing will give more accurate results as compared to other methods. This would be possible if the number of activities are recorded appropriately and are easily marked project wise.
If there is need to borrow funds to fund the construction of an
asset, the interest paid on these borrowings is a cost related to
the asset and it must be capitalized as per the GAAP. It is not
expensed. But keep in mind, interest incurred only till the
construction is complete. The capitalization period for interest
begins when purchases are made . This period ends when asset is
ready to use.