Question

The cost of acquiring an asset includes the costs necessary to bring it to the condition and location necessary for its intended use. there are four stages during which costs can be incurred related to fixed assets:

·         Preliminary stage,

·         Pre-acquisition stage,

·         Acquisition or construction stage (herein referred to as the construction stage),

·         In-service stage

Please, provide a summary of some types of costs incurred during all stages of construction or acquisition of a capital asset/project. Discuss what sort of costs can be capitalized during each of the stages.

Answer 1

Summary of some types of costs incurred during all stages of construction or acquisition of capital asset/ project -

Stage 1 - Preliminary Stage

Preliminary Stage of the asset is the very first step of acquiring the asset. The expenses incurred during this stage is for the purpose of acquiring the asset and before acquiring the asset. During this stage, the pros and cons of purchasing or constructing the asset are studied.

Examples of preliminary stage costs are - cost of surveys, cost of planning and designing, environmental study costs, feasibility study costs, other professional fees etc.

The preliminary stage costs are capitalized if it is probable that the asset/ project would be purchased or constructed.

Stage 2 - Pre acquisition stage

Pre acquisition stage is somewhat similar to preliminary stage of an asset. That is costs incurred during this stage is for the purpose of purchasing or constructing the asset and commencing the activities for purchase or construction.

Examples of pre acquisition costs are also similar to preliminary stage costs. Example- payment to obtain the land.

Pre acquisition stage costs are capitalized if it is probable that the asset / project would be purchased or constructed . And the costs are are identified and directly related to purchase or construction of asset / project.

Stage 3 - Acquisition or construction stage

In this third stage, finally the asset is purchased or manufactured. Acquisition or construction stage costs include all those costs which are necessary to bring it to the location or condition necessary for its intended use.

Examples - Purchase costs, delivery costs, legal charges, installation costs, upgradation costs, handling charges, freight, any duties and taxes paid etc.

Administrative costs and abnormal losses are not recognised.

Acquisition or construction stage costs are capitalized. Therefore, preliminary stage costs, pre acquisition stage costs and acquisition or construction stage costs are added to the cost of an asset.

Stage 4 - In service stage

In service stage costs are the costs incurred after the purchase or construction of an asset. In service stage costs are incurred to maintain the asset and not to enhance or increase the revenue generating capacity of an asset. Therefore, in service stage costs are classified as revenue expenses in the income statement in the period in which they are incurred.

Examples - Repair costs, maintaince charges, repainting costs, renewal expenses etc.