Acquisition and Disposition
of Property, Plant, and Equipment
ANSWERS TO QUESTIONS
1. The major characteristics of plant assets are (1) that they are acquired for use in operations and not for resale, (2) that they are long-term in nature and usually subject to depreciation, and (3) that they have physical substance.
2. The company should report the asset at its historical cost of $420,000, not its current value. The main reasons for this position are (1) at the date of acquisition, cost reflects fair value; (2) historical cost involves actual, not hypothetical transactions, and as a result is extremely reliable; and (3) gains and losses should not be anticipated but should be recognized when the asset is sold.
The acquisition costs of land may include the purchase or contract price, the broker’s commission, title search and recording fees, assumed taxes or other liabilities, and surveying, demolition (less salvage), and landscaping costs.
(b) Machinery and equipment costs may properly include freight and drayage (handling), taxes on purchase, insurance in transit, installation, and expenses of testing and breaking-in.
(c) If a building is purchased, all repair charges, alterations, and improvements necessary to ready the building for its intended use should be included as a part of the acquisition cost. Building costs in addition to the amount paid to a contractor may include excavation, permits and licenses, architect’s fees, interest accrued on funds obtained for construction purposes (during construction period only) called avoidable interest, insurance premiums applicable to the construction period, temporary buildings and structures, and property taxes levied on the building during the construction period.
(d) Machinery. The only controversy centers on whether fixed overhead should be allocated as a cost to the machinery. (e) Land Improvements, may be depreciated.
(g) Building, provided the benefits in terms of information justify the additional cost involved in providing the information (FASB Statement No. 34). (h) Land.
The position that no fixed overhead should be capitalized assumes that the construction of plant (fixed) assets will be timed so as not to interfere with normal operations. If this were not the case, the savings anticipated by constructing instead of purchasing plant assets would be nullified by reduced profits on the product that could have been manufactured and sold. Thus, construction of plant assets during periods of low activity will have a minimal effect on the total amount of overhead costs. To capitalize a portion of fixed overhead as an element of the cost of constructed assets would, under these circumstances, reduce the amount assignable to operations and therefore overstate net income in the construction period and understate net income in subsequent periods because of increased depreciation charges.
(b) Capitalizing overhead at the same rate as is charged to normal operations is defended by those who believe that all manufacturing overhead serves a dual purpose during plant asset construction periods. Any attempt to assign construction activities less overhead than the normal rate implies costing favors and results in the misstatement of the cost of both plant assets and finished goods.
Questions Chapter 10 (Continued)
Disagree. Organization and promotion expenses should be expensed.
Agree. Architect’s fees for plans actually used in construction of the building should be charged to the building account as part of the cost.
Agree. FASB Statement No. 34 recommends that avoidable interest or actual interest cost, whichever is lower, be capitalized as part of the cost of acquiring an asset if a significant period of time is required to bring the asset to a condition or location necessary for its intended use. Interest costs are capitalized...
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