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Chapter 10: Q5Q (page 530)

Question: Two positions have normally been taken with respect to the recording of fixed manufacturing overhead as an element of the cost of plant assets constructed by a company for its own use: (a) It should be excluded completely. (b) It should be included at the same rate as is charged to normal operations.

What are the circumstances or rationale that support or deny the application of these methods?

Short Answer

Expert verified

Answer

Rationale for exclusion is fixed manufacturing cost did not increase the cost of the company. Rationale for inclusion is cost incurred is related to the construction or production of all goods and assets.

Step by step solution

01

Rationale for the complete exclusion of the fixed manufacturing overhead cost

According to the argument, fixed manufacturing cost is excluded from the cost of plant assets constructed by the company for own use. Reason behind the exclusion of the assets is that fixed manufacturing overhead considers as fixed cost. But fixed cost does not increase when company construct the asset. As per this argument, fixed cost of company remains same whether company construct asset or not.

02

Rationale for inclusion of fixed manufacturing overhead rate

According to this argument, fixed manufacturing overhead is allocated on the pro rata basis to the constructed assets as it is charged to normal operations. Because in this approach, it is follows that all cost incurred also attached to the constructed assets along with normal production.

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Most popular questions from this chapter

(Acquisition Costs of Realty) The following expenditures and receipts are related to land, land improvements,

and buildings acquired for use in a business enterprise. The receipts are enclosed in parentheses.

(a) Money borrowed to pay building contractor (signed a note) \((275,000)

(b) Payment for construction from note proceeds 275,000

(c) Cost of land fill and clearing 8,000

(d) Delinquent real estate taxes on property assumed by purchaser 7,000

(e) Premium on 6-month insurance policy during construction 6,000

(f) Refund of 1-month insurance premium because construction completed early (1,000)

(g) Architect’s fee on building 22,000

(h) Cost of real estate purchased as a plant site (land \)200,000 and building $50,000) 250,000

(i) Commission fee paid to real estate agency 9,000

(j) Installation of fences around property 4,000

(k) Cost of razing and removing building 11,000

(l) Proceeds from salvage of demolished building (5,000)

(m) Interest paid during construction on money borrowed for construction 13,000

(n) Cost of parking lots and driveways 19,000

(o) Cost of trees and shrubbery planted (permanent in nature) 14,000

(p) Excavation costs for new building 3,000

Instructions

Identify each item by letter and list the items in columnar form, using the headings shown below. All receipt amounts should be

reported in parentheses. For any amounts entered in the Other Accounts column, also indicate the account title.

Item Land Land Improvements Buildings Other Accounts

(Nonmonetary Exchange) Dana Ashbrook Inc. has negotiated the purchase of a new piece of automatic equipment at a price of \(8,000 plus trade-in, f.o.b. factory. Dana Ashbrook Inc. paid \)8,000 cash and traded in used equipment. The used equipment had originally cost \(62,000; it had a book value of \)42,000 and a secondhand fair value of \(47,800, as indicated by recent transactions involving similar equipment. Freight and installation charges for the new equipment required a cash payment of \)1,100.

Instructions

  1. Prepare the general journal entry to record this transaction, assuming that the exchange has commercial substance.
  2. Assuming the same facts as in (a) except that fair value information for the assets exchanged is not determinable, prepare the general journal entry to record this transaction.

Magilke Industries acquired equipment this year to be used in its operations. The equipment was delivered by the suppliers, installed by Magilke, and placed into operation. Some of it was purchased for cash with discounts available for prompt payment. Some of it was purchased under long-term payment plans for which the interest charges approximated prevailing rates. What costs should Magilke capitalize for the new equipment purchased this year? Explain.

Question: (Entries for Equipment Acquisitions) Jane Geddes Engineering Corporation purchased conveyor equipment with a list price of \(10,000. Presented below are three independent cases related to the equipment. (Round to the nearest dollar.)

  1. Geddes paid cash for the equipment 8 days after the purchase. The vendor’s credit terms are 2/10, n/30. Assume that equipment purchases are initially recorded gross.
  2. Geddes traded in equipment with a book value of \)2,000 (initial cost \(8,000), and paid \)9,500 in cash one month after the purchase. The old equipment could have been sold for \(400 at the date of trade. (The exchange has commercial substance.)
  3. Geddes gave the vendor a \)10,800 zero-interest-bearing note for the equipment on the date of purchase. The note was due in one year and was paid on time. Assume that the effective-interest rate in the market was 9%.

Instructions

Prepare the general journal entries required to record the acquisition and payment in each of the independent cases above.

Question: One financial accounting issue encountered when a company constructs its own plant is whether the interest cost on funds borrowed to finance construction should be capitalized and then amortized over the life of the assets constructed. What is the justification for capitalizing such interest?
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