Question

To what extent do you consider the following items to be proper costs of the fixed asset? Give reasons for your opinions.

1. Overhead of a business that builds its own equipment.
2. Cash discounts on purchases of equipment.
3. Interest paid during the construction of a building.
4. Cost of a safety device installed on a machine.
5. Freight on equipment returned before installation, for replacement by other equipment of greater capacity.
6. Cost of moving machinery to a new location.
7. Cost of plywood partitions erected as part of the remodeling of the office.
8. Replastering of a section of the building.
9. Cost of a new motor for one of the trucks.

Short answer

1. A plant asset account is charged for overhead.
2. Plant assets should be written off to expense.
3. Avoidable or actual interest cost, whichever is lower, be capitalized.
4. The cost of a safety device should be capitalized.
5. The freight should be regarded as a loss.
6. The cost of one installation should be capitalized for any piece of equipment.
7. Remodeling costs may be capitalized.
8. Re-plastering should be treated as an expense.
9. Extraordinary repair should be charged against the accumulated depreciation on the truck.

Step-by-step solution

Meaning of Fixed Asset

In accounting terms, a fixed asset is atangible used for more than one year. All fixed assets except land have a tenancy for depreciation on account of obsolescence, and depreciation expense is charged to the books of accounts every year.

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

Some accountants believe that the increased overhead created by such a building should be charged to the equipment account. When overhead is charged to the plant asset account on the same basis and at the same pace as output, a more accurate number for equipment cost emerges.

(b) Cash discounts on purchases of equipment

Some accountants consider all cash discounts to be financial or other income, regardless of whether they stem from the payment of product or plant assets bills. Others argue that because the discount indicates a price decrease rather than revenue, only the net amount spent for plant assets should be capitalized. The latter stance appears more plausible because plant assets are acquired for use rather than sale and written down to expenditure over time.

(c) Interest paid during the construction of a building

Suppose sufficient time is required to get an asset to the condition and location required for its intended use. In that case, avoidable or actual interest costs, whichever is smaller, be capitalized as part of the acquisition cost.

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

If material is added to the machine, which increases the life or utility of the fixed asset, it should be capitalized in the machinery account.

(e) Freight on equipment returned before installation

For replacement by other equipment of greater capacity.The freight should be considered a loss if ordering the original equipment was a mistake, whether due to judgment or otherwise. If information becomes available after the order is placed indicating that purchasing new equipment is more advantageous, the cost of return freight may be considered a required expense of the new equipment.

(f) Cost of moving machinery to a new location

For every piece of equipment, only the cost of one installation should be capitalized. As a result, the original installation and any accrued depreciation should be deducted from the accounts, while the new installation expenses (i.e., relocation costs) should be capitalized. If this is not practicable and the cost of relocation is significant, it is capitalized and depreciated properly throughout the period it is to operations.

(g) Cost of plywood partitions erected in the remodeling of the office

This is included in the renovation cost and may be capitalized if the remodeling is of such character that it is an addition to the structure rather than just a replacement or repair.

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

This appears to be more of a repair than anything else and, as such, should be considered a cost

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

The truck's useful life is likely to be extended due to this. As a result, it might be considered an unusual repair and deducted from the truck's total depreciation. Estimate the truck's remaining service life and adjust the depreciation to write off the net book value, minus salvage, over the remaining useful life. If feasible, delete the old motor's cost and related depreciation and add the new motor's cost.