Question

The invoice price of a machine is \(50,000. Various other costs relating to the acquisition and installation of the machine, including transportation, electrical wiring, special base, and so on amount to \)7,500. The machine has an estimated life of 10 years, with no salvage value at the end of that period.

The owner of the business suggests that the incidental costs of \(7,500 be charged to theexpense immediately for the following reasons.

1. If the machine should be sold, these costs cannot be recovered in the sales price.
2. The inclusion of the \)7,500 in the machinery account on the books will not necessarily result in a closer approximation of the market price of this asset over the years, because of the possibility of changing demand and supply levels.
3. Charging the $7,500 to expense immediately will reduce federal income taxes.

Instructions

Discuss each of the points raised by the owner of the business.

Short answer

1. Installation costs could not be recovered if the machine were to be sold.
2. The purpose of accounting for plant assets is not to arrive at an approximation of the fair value of the assets each year over the life of the assets.
3. GAAP requires a different accounting treatment of an item than the IRS.

Step-by-step solution

Meaning of Acquisition of cost

In accounting terms, acquisition cost alludes to acquiring a particular thing. There are three common trade contexts when it is utilized: mergers and acquisitions, fixed resources, and client acquisition.

(1) Explaining the points raised by owners.

Including the $7,500 as part of the machine's cost is appropriate because the major goal of accounting for plant asset expenses is to ensure an equal distribution of incurred costs when the assets' benefits are obtained.

Both the $50,000 and the $7,500 charges are prepaid expenses that must be offset by the revenue generated by their utilization. Plant asset accounting aims not to determine the asset's fair value for balance sheet reasons but to ensure that incurred expenditures are properly matched with income generated by the assets.

It's possible that these installation charges won't be recouped if the equipment is sold. This is immaterial because the computer was most likely purchased to be used rather than sold. Assuming that the machine is used roughly equally across the ten years, the owner might correctly allocate $5,750 (10 percent of $57,500) to each year's operations.

If the owner's recommendation were implemented, the first year would be charged with $12,500 ($7,500 + 10% of $50,000), and the subsequent nine years with $5,000, resulting in a $6,750 overstatement in the first year and a $750 understatement in the remaining nine years. This could scarcely be described as adequate cost-to-revenue matching.

(2) Explaining the points raised by owners.

Again, the goal of plant asset accounting isn't to arrive at a close estimate of fair value each year during the asset's lifetime. Even if this were an aim, the question of which approach would be closest to presenting current market worth at a later period would center on the overall pattern of the price level during the years in question.

(3) Explaining the points raised by owners.

If the $7,500 could be legally deducted, there would be some tax savings over time unless the appropriate tax rates for the firm were cut in subsequent years. Because of the current worth of money, taking the $7,500 deduction now has some value.

If the rates were raised, overall taxes would rise because higher rates would apply when depreciation deductions decreased. However, income tax consequences have no bearing on commonly recognized accounting rules. In many cases, GAAP dictates a different accounting procedure than the IRS Revenue Code.