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Chapter 9 - Solution Manual

Because future periods will benefit from the extra

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use of this machine. Because future periods will benefit from the extra outlays required to develop the initial machine, all development costs should be capitalized and subsequently associated with the related revenue produced by the sale of products manufactured. If, however, it can be determined that the excess cost of producing the first machine was the result of inefficiencies or failures which did not contribute to the machine's successful development, these costs should be recognized as an extraordinary loss. Subsequent periods should not be burdened with charges arising from costs which are not expected to yield future benefits. Capitalizing the excess costs as a cost of the initial machine can be justified under the general rules of asset valuation. That is, an asset acquired should be charged with all costs incurred in obtaining the asset and placing it in productive use. A case could also be made for prorating the excess cost of developing the first machine equally to all four machines on the grounds that these costs were necessary in order to obtain the four machines. In this case, the acquisition of the four machines is analogous to a "basket" purchase where proration is acceptable. Although less supportable, another alternative treatment of the excess costs of developing the initial machine is to treat the costs as research and development. Under current GAAP costs of research and development are expensed as incurred. Case 9-5 a. The fair market value of the acquired site, as evidenced by the contract price, is $60,000. It is the amount that represents the actual bargained price of the land in a cash transaction. To charge any portion of the option costs to the land account is to disregard the bargained price of the acquired site and, further, implies that the land is more valuable because of the options. The purchase of the options enabled the client to delay his/her selection of a site until the advantages and disadvantages of each were carefully weighted. The benefits to be derived from the net advantage of the selected site over the rejected sites will accrue to the operations of the contemplated plant facility. The cost of the options should therefore be separately capitalized and allocated to the periods benefited. It may also be argued that the cost of the options represents management's failure to plan for the acquisition of a site. Such a contention leads to the conclusion that the cost of the option is a loss and should be expensed immediately, and it supports the recording of the cost of the acquired site at $60.000. b. The actual cost of the selected site is the sum of the contract price plus the cost of the option which was exercised to purchase the land. All costs incurred to secure title to the land are properly includable as part of its cost. However, to capitalize the cost of the options that were allowed to lapse would be inappropriate. They have no bearing on the acquisition of effective title to the selected site and should be treated as a loss.
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