Question

Two positions have normally been taken with respect to the recording of fixed manufacturing overhead as an element of the cost of plant assets constructed by a company for its own use: (a) It should be excluded completely. (b) It should be included at the same rate as is charged to normal operations. What are the circumstances or rationale that support or deny the application of these methods?

Answer 1

The circumstances or rationale that support to the recording of fixed manufacturing overhead as an element of the cost of plant assets constructed by a company for its own use:

(a) It should be excluded completely means no fixed overhead cost of plant assets constructed by a company for its own use; rationale that support it is fixed overhead cost is already there and it’s only going to increase due to constructing the plant assets of the company. This method assumes that the company is going to incur same fixed overhead costs irrespective of whether it constructs its own assets or not. Otherwise company’s income of that period will be overstated as the expenses will reduced due to charging a portion to fixed assets.

(b) It should be included at the same rate as is charged to normal operations. This method is known as full-costing method as company allocates a portion of fixed overhead cost to the construction assets like the normal production costs which are attach to all products and assets constructed either for own use or for sell. The rationale behind this is a better matching of costs with revenues for same period and this method is extensively followed by the companies. This method also assumes that not to understate the initial cost of the asset otherwise it will lead to an inaccurate future allocation of resources.