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Chapter 10: Q5CA (page 548)

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

Expert verified
  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

01

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.

02

(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.

03

(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.

04

(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.

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Most popular questions from this chapter

Garcia Corporation purchased a truck by issuing an $80,000, 4-year, zero-interest-bearing note to Equinox Inc. The market rate of interest for obligations of this nature is 10%. Prepare the journal entry to record the purchase of this truck.

Question: Mickelson Inc. owns land that it purchased on January 1, 2000, for \(450,000. At December 31, 2017, its current value is \)770,000 as determined by appraisal. At what amount should Mickelson report this asset on its December 31, 2017, balance sheet? Explain

(Capitalization of Interest) Harrisburg Furniture Company started construction of a combination office and warehouse building for its own use at an estimated cost of \(5,000,000 on January 1, 2017. Harrisburg expected to complete the building by December 31, 2017. Harrisburg has the following debt obligations outstanding during the construction period.

Construction loan鈥�12% interest, payable semiannually, issued December 31, 2016

\)2,000,000

Short-term loan鈥�10% interest, payable monthly, and principal payable at maturity on May 30, 2018

1,400,000

Long-term loan鈥�11% interest, payable on January 1 of

each year. Principal payable on January 1, 2021

1,000,000

Instructions

(Carry all computations to two decimal places.)

(A) Assume that Harrisburg completed the office and warehouse building on December 31, 2017, as planned at a total cost of \(5,200,000, and the weighted-average amount of accumulated expenditures was \)3,600,000. Compute the avoidable interest on this project.

(B) Compute the depreciation expense for the year ended December 31, 2018. Harrisburg elected to depreciate the building on a straight-line basis and determined that the asset has a useful life of 30 years and a salvage value of $300,000.

Martin Buber Co. purchased land as a factory site for \(400,000. The process of tearing down two old buildings on the site and constructing the factory required 6 months. The company paid \)42,000 to raze the old buildings and sold salvaged lumber and brick for \(6,300. Legal fees of \)1,850 were paid for title investigation and drawing the purchase contract. Martin Buber paid \(2,200 to an engineering firm for a land survey, and \)68,000 for drawing the factory plans. The land survey had to be made before definitive plans could be drawn. Title insurance on the property cost \(1,500, and a liability insurance premium paid during construction was \)900. The contractor鈥檚 charge for construction was \(2,740,000. The company paid the contractor in two installments: \)1,200,000 at the end of 3 months and \(1,540,000 upon completion. Interest costs of \)170,000 were incurred to finance the construction. Instructions Determine the cost of the land and the cost of the building as they should be recorded on the books of Martin Buber Co. Assume that the land survey was for the building.

Question: (Classification of Acquisition and Other Asset Costs) At December 31, 2016, certain accounts included in the property, plant, and equipment section of Reagan Company鈥檚 balance sheet had the following balances.

Land

\(230,000

Buildings

890,000

Leasehold improvements

660,000

Equipment

875,000

During 2017, the following transactions occurred.

  1. Land site number 621 was acquired for \)850,000. In addition, to acquire the land Reagan paid a \(51,000 commission to a real estate agent. Costs of \)35,000 were incurred to clear the land. During the course of clearing the land, timber and gravel were recovered and sold for \(13,000.
  2. A second tract of land (site number 622) with a building was acquired for \)420,000. The closing statement indicated that the land value was \(300,000 and the building value was \)120,000. Shortly after acquisition, the building was demolished at a cost of \(41,000. A new building was constructed for \)330,000 plus the following costs.

Excavation fees

\(38,000

Architectural design fees

11,000

Building permit fee

2,500

Imputed interest on funds used

during construction (stock financing)

8,500

The building was completed and occupied on September 30, 2017.

  1. A third tract of land (site number 623) was acquired for \)650,000 and was put on the market for resale.
  2. During December 2017, costs of \(89,000 were incurred to improve leased office space. The related lease will terminate on December 31, 2019, and is not expected to be renewed. (Hint: Leasehold improvements should be handled in the same manner as land improvements.)
  3. A group of new machines was purchased under a royalty agreement that provides for payment of royalties based on units of production for the machines. The invoice price of the machines was \)87,000, freight costs were \(3,300, installation costs were \)2,400, and royalty payments for 2017 were $17,500.

Instructions

a, Prepare a detailed analysis of the changes in each of the following balance sheet accounts for 2017.

Land Leasehold Improvements

Buildings Equipment

Disregard the related accumulated depreciation accounts.

b, List the items in the situation that were not used to determine the answer to (a) above, and indicate where, or if, these items should be included in Reagan鈥檚 financial statements.
See all solutions

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