Chapter 8 - Solution Manual

In addition entre is required by the government to

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In addition, Entre is required by the government to remove underground tanks and to refine the soil. The cost to remove the tanks is $40,000 and the cost to refine the soil is $30,000. Like the cost incurred to remove the building these costs are necessary to get the land ready to build the building. Without incurring these costs, Entre cannot build the restaurant and will not be able to receive future benefits (return) from his investment. Thus, we argue that these costs meet the definition of an asset and are consistent with the historical cost principle. Obviously, the $1,800,000 cost incurred to construct the building to house the restaurant should be capitalized as part of the building cost. The building is arguably an asset. It will be used as Entre’s place of business where his employees will prepare and serve food to customers. Thus, it meets the definition of an asset because it provides a probable future benefit. In addition, the FASB determined in SFAS No. 34 , that avoidable interest incurred to construct an asset, such as Entre’s restaurant, should be capitalized as a part of the cost of the asset. It is a necessary cost to construct the asset because had the asset not been constructed the debt used to finance the construction and thus the cost of borrowing (interest) could have been avoided. Because it could have been avoided, the interest is deemed to be necessary to acquire the asset and get it ready for its intended use. Thus, capitalization of $22,000 of avoidable interest incurred during construction as part of the asset’s cost is consistent with the historical cost principle. Team 2: Criticize capitalization of the cost to remove the tanks and refine the soil and the capitalization of interest during construction. Do they provide added service potential? Your arguments should utilize the Conceptual Framework definitions and concepts We believe that neither the costs of removing the tanks and refining the soil nor the cost of avoidable interest incurred during construction of the restaurant should be capitalized and reported as costs of assets. Our argument is based primarily on the position that these expenditures do not add future service potential to the land or to the building. Thus, they do not meet the definition of an asset. This means that if we report these costs as assets we would be violating the qualitative characteristic of
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166 representational faithfulness. We would be reporting a non-asset as an asset. Thus, it would not be what it purports to be. SFAC No. 6 defines an asset as a probable future economic benefit obtained or controlled by a particular entity as a result of a past transaction. Neither removing the tanks at a cost of $40,000 nor incurring a $30,000 expenditure to refine the soil once the tanks are removed does not increase the expected future cash inflow from the operation of the restaurant. Thus, it provides no future benefit and is not an asset.
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