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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

Use the information for Hanson Company from BE10-2 and BE10-3. Compute avoidable interest for Hanson Company.

Hanson Company is constructing a building. Construction began on February 1 and was completed on December 31. Expenditures were \(1,800,000 on March 1, \)1,200,000 on June 1, and \(3,000,000 on December 31.

Hanson Company borrowed \)1,000,000 on March 1 on a 5-year, 12% note to help finance construction of the building. In addition, the company had outstanding all year a 10%, 5-year, \(2,000,000 note payable and an 11%, 4-year, \)3,500,000 note payable

Question: Once equipment has been installed and placed in operation, subsequent expenditures relating to this equipment are frequently thought of as repairs or general maintenance and, hence, chargeable to operations in the period in which the expenditure is made. Actually, determination of whether such an expenditure should be charged to operations or capitalized involves a much more careful analysis of the character of the expenditure. What are the factors that should be considered in making such a decision? Discuss fully.

Question: Provide examples of assets that do not qualify for interest capitalization

Mohave Inc. purchased land, building, and equipment from Laguna Corporation for a cash payment of \(315,000. The estimated fair values of the assets are land \)60,000, building \(220,000, and equipment \)80,000. At what amounts should each of the three assets be recorded?

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.
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