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CA 10-2 - incremental costs should be charged 2 Proponents...

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CA 10-2 (a) Materials and direct labor used in the construction of the equipment definitely should be charged to the equipment account. It should be emphasized that no gain on self-construction should be recorded because such an approach violates the historical cost principle. The controversy centers on the assignment of indirect costs, called overhead or burden, consisting of power, heat, light, insurance, property taxes on factory buildings, etc. The suggested approaches are discussed below. (b) 1. Many believe that only the variable overhead costs that increase as a result of the construction should be assigned to the cost of the asset. This approach assumes that the company will have the same fixed costs regardless of whether the company constructs the asset or not, so to charge a portion of the fixed overhead costs to the equipment will usually decrease current expenses and consequently overstate income of the current period. Therefore, only the
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Unformatted text preview: incremental costs should be charged. 2. Proponents of alternative (2) argue that such assets should be given the same treatment as inventory items and that all costs should be allocated thereto just as if saleable goods were being produced. They state that no special favor should be granted in the allocation of any cost, as long as sufficient facts are available to enable the allocation to be made. They argue that allocation of overhead to fixed assets is similar to allocation to joint products and byproducts, and should be made at regular rates. Of course, no item should be capitalized at an amount greater than that prevailing in the market. (c) It could be argued that because costs of development are usually higher on the first few units, the additional costs of $273,000 should be allocated to all four machines. If these costs are due to inefficiency and not development costs, the additional costs should be expensed....
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