Question

Case9-4 Self-constructed asset (page 295)

Due to growing demand of a new product, Jay Manufacturing, Inc. needs to expand its product line but cannot find an outside supplier for the expansion so decides to design and build the equipment. In 2017, a section of the plant was devoted to development of the new equipment and a special staff of personnel was hired. Within 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.

Required:

1. In general, what costs should be capitalized for a self-constructed asset?
2. Discuss pros and cons of including these charges 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 (consider whether the company is at full capacity)
3. 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.

Answer 1

ANS. 1) THE COMPANY HAS INCURRED EXPENDITURE OF $170,000 ON DEVELOPING NEW MACHINE . SUBSEQUENTLY ON SUCCESS OF MACHINE THE COMPANY BUILD THRE MORE MACHINE AT COST OF $80,000 EACH

COST OF FIRST DEVELOPED MACHINE $170,000

NEXT DEVELOPED MACHINE COST $ 80,000

EXTRA EXPENDITURE O DEVELOPED MACHINE $ 170,000-$80,000=$90,000

THIS EXTRA EXPENDITURE CAN BE TOWARDS RESEARCH AND DEVELOPMENT EXENSES AND CAN BE AMORTISED OVER THE LIFE SPAN OF MACHINE OR PERIOD OF 10 YEARS

CAPITALIZED COST OF MACHINE WOULD BE $80000 FOR EACH MACHINE TOTALLING $80,000*4=$320,000

2) IF COST OF DEELOPMENT IS INCLUED IN CAPITALIZED ASSET THEN IT WILL INCREASE THE VALE OF CAPITAL ASSET BUT ACTUALLY IT IS NOT . SO IT WILL BE BENEFICIAL TO INCLUDE THEIS AS AN RESEARCH AND DEVELOPENT EXPENDITUREWHICH WOULD BE AMORTISED OVER THE PERIOD

INCLUSION WOULD UNNECESSARILY INCREASE THE VALUE OF ASSET

ON MANUFACTURING OF NEW MACHINARY IF THERE IS INCREASE IN AMOUNT OF OVERHEAD THEN PROERTION OF OVERHEAD EQUAL THE AMOUNT OF MACHINE HOURS SPENDING FOR THE DEVELOPMENT OF MACHINE WOULD BE INCLUDED IN COST OF MACHINE NOT TO THE GOODS MANUFACTURE WHICH WOULD INCREASE THE COST OF GOODS MANUFACTURED.