Question

(Contract Costs) Rex’s Reclaimers entered into a contract with Dan’s Demolition to manage the processing of recycled materials on Dan’s various demolition projects. Services for the 3-year contract include collecting, sorting, and transporting reclaimed materials to recycling centers or contractors who will reuse them. Rex’s incurs selling commission costs of \(2,000 to obtain the contract. Before performing the services, Rex’s also designs and builds receptacles and loading equipment that interfaces with Dan’s demolition equipment at a cost of \)27,000. These receptacles and equipment are retained by Rex’s and can be used for other projects. Dan’s promises to pay a fixed fee of \(12,000 per year, payable every 6 months for the services under the contract. Rex’s incurs the following costs: design services for the receptacles to interface with Dan’s equipment \)3,000, loading equipment controllers \(6,000, and special testing and OSHA inspection fees \)2,000 (some of Dan’s projects are on government property).

Instructions

(a) Determine the costs that should be capitalized as part of Rex’s Reclaimers revenue arrangement with Dan’s Demolition.

Short answer

The total capital cost is $38,000.

Step-by-step solution

Capital Cost

Capital costs are expenses that give a benefit to a company over a longer period of time and are thus added to assets and depreciated in accounting.

Cost that should be capitalized

Rex must capitalize all expenditures associated with building the receptacles and preparing them for their intended usage. However, he is unable to capitalize on selling expenditures such as the commission paid to secure the contract.

The entire cost that has to be capitalized is:

$\begin{array}{rcl}\mathrm{Total}\mathrm{capital}\mathrm{cost}& =& \mathrm{Construction}\mathrm{of}\mathrm{the}\mathrm{receptacles}+\mathrm{Design}\mathrm{services}+\mathrm{Loaning}\mathrm{equipment}\mathrm{controllers}+\mathrm{Special}\mathrm{testing}\mathrm{and}\mathrm{OSHA}\mathrm{inspection}\mathrm{fees}\\ & =& \$27,000+\$3,000+\$6,000+\$2,000\\ & =& \$38,000\end{array}$