Question

To what extent do you consider the following items to be proper costs of the fixed asset? Give reasons for your opinions.(a) Overhead of a business that builds its own equipment.(b) Cash discounts on purchases of equipment.(c) Interest paid during construction of a building.(d) Cost of a safety device installed on a machine.(e) Freight on equipment returned before installation, for replacement by other equipment of greater capacity.(f) Cost of moving machinery to a new location.(g) Cost of plywood partitions erected as part of the remodeling of the office.(h) Re-plastering of a section of the building.(i) Cost of a new motor for one of the trucks.

6 points

Your answer

Answer 1

(a) Overhead of a business that builds its own equipment.

Overheads for the business which is developing own equipments should form part of cost of building an equipment since that cost is directly attributable to the maufacturing of an asset.

(b) Cash discounts on purchases of equipment.

Cash discount on purchase of equipment should be reduced from the cost of fixed asset since less price has to be paid for bringing asset.

(c) Interest paid during construction of a building.

Interest paid during the construction of a building should be capitalized since asset has not come into existence and it will for part of cost of construction.

(d) Cost of a safety device installed on a machine.

Cost of safety device installed on machine is to be capitalized since same will be used over a period of time and it is non recurring expense and should form part of cost of fixed assets to be amortized over a period of years.

(e) Freight on equipment returned before installation, for replacement by other equipment of greater capacity.

Freight on equipment returned to be replaced by new one should form part of cost of purchase of new equipment since that freight is being paid for asset to be purchased.

(f) Cost of moving machinery to a new location.

Cost of moving machinery should not form part of cost of fixed assets since it will not add any useful life to the assets. Hence it should be treated as an expense.

(g) Cost of plywood partitions erected as part of the remodeling of the office.

Cost of plywood partitions for renovation of office should be treated as revenue expenditure and not to be capitalized since it will not add any useful life to the assets.

(h) Re-plastering of a section of the building.

It should not be capitalized since it will not improve number of useful life and it is normal repair of fixed asset and should be treated as revenue expenditure.

(i) Cost of a new motor for one of the trucks.

Cost of new motor if installed at the time of acquisition of used truck will be capitalized. However if trucks are already being used and new motor is added, then it should be treated as revenue expenditure and should not form part of cost of truck.