Treatment Of Various Costs - Allegro Supply Company

Treatment Of Various Costs Allegro Supply Company A Newly

E10-5 (Treatment of Various Costs) Allegro Supply Company, a newly formed corporation, incurred several expenditures related to Land, Buildings, and Machinery and Equipment. These expenses include costs for title search, architect’s fees, purchase of land and dilapidated building, removal of old building, interest during construction, excavation, purchase and delivery of machinery, construction of a new building, city drainage assessment, installation, and landscaping. Determine the amounts that should be debited to Land, Buildings, and Machinery and Equipment. Assume the benefits of capitalizing interest during construction exceed the costs, and indicate how any costs not debited to these accounts should be recorded.

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In the realm of accounting for property, plant, and equipment, understanding which costs should be capitalized versus expensed is crucial for accurately reflecting a company's financial position. The expenditures incurred by Allegro Supply Company encompass various categories, each qualifying for different treatment based on accounting principles such as GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards). Proper classification affects not only the balance sheet presentation but also depreciation and financial ratios, which are essential in assessing the company’s asset management and financial health.

Initial Costs and Land

The costs directly associated with acquiring land are generally capitalized as part of the land's cost. This includes the purchase price, title search fees, and costs related to preparing the land for use. In this case, Allegro paid $520 for the title search, and $92,000 for land and a dilapidated building. The removal of the old building, costing $20,000 with a salvage value of $5,500, should be evaluated next. Since the old building is being demolished, the cost of removal is capitalized as part of land if it is necessary to prepare the land for use. The salvage value of $5,500 reduces the demolition cost, resulting in a net expense of $14,500 ($20,000 - $5,500). Excursion and excavation costs, amounting to $19,000, are also capitalized as part of land because they are necessary to prepare the land for its intended use.

Construction of Building

The costs associated with constructing the building, such as architect’s fees ($3,170), the actual construction costs ($485,000), and city drainage assessments ($1,600), should be capitalized as part of the building asset. The architect's fees relate directly to the design and planning of the building, and thus, are capital costs. The city drainage assessment benefits the building and its land development, so it is also capitalized. Expenses related to storage, like storage charges of $2,180 due to delays, are considered necessary to bring the asset to its intended condition and are capitalized.

Machinery and Equipment

The purchase of machinery, priced at $65,000 before discounts, along with freight charges of $1,340, and installation costs of $2,000, qualify for capitalization as Machinery and Equipment. Despite the fact that a 2% cash discount was not taken, the cost basis remains $65,000. The freight costs directly attributable to transportation are included in the equipment’s cost. Installation costs are also capitalized because they prepare the machinery for use. Storage charges during delays ($2,180) are usually expensed unless they are clearly attributable primarily to bringing the asset to its intended use; in this case, they are better treated as operating expenses. Furthermore, the hauling charges ($620) to deliver machinery to the construction site are capitalized as part of the machinery’s cost.

Interest During Construction

According to accounting standards, interest on short-term loans used specifically for construction can be capitalized as part of the cost of the constructed asset, provided the benefits exceed the costs. In Allegro's case, interest of $7,400 incurred during the six-month construction period is capitalized. This practice aligns with GAAP, which allows the capitalization of interest during construction to better match expenses with the period benefitted.

Landscaping and Landscaping Cost

The cost of landscaping (trees, shrubs, and other permanent improvements) totaling $5,400 is capitalized when these improvements are permanent in nature, enhancing the property's value. Landscaping that is of a permanent nature is treated as part of the land improvements, often capitalized alongside the land or as a separate land improvement asset. In this context, these costs increase the value of the land or land improvements rather than the building or machinery.

Costs Not Capitalized

Some costs incurred, including storage charges ($2,180) and salvage value deductions ($5,500), are expenses or adjustments rather than capital costs. Storage charges during construction are typically operational expenses and should be recorded in the income statement as incurred. Salvage value reduces demolition costs and is used to offset expense recognition. Costs that do not directly contribute to bringing the asset to its intended use are expensed. Similarly, interest costs that are not related to specific construction projects should be expensed as financing costs unless they are directly attributable and meet capitalizability criteria, which in this case, they do.

Summary of Capitalized Costs

Based on the analysis, the following amounts are debited:

  • Land:
    • Title search: $520
    • Purchase price: $92,000
    • Demolition costs net salvage: $14,500
    • Excavation: $19,000
  • Buildings:
    • Architect’s Fees: $3,170
    • Construction costs: $485,000
    • City drainage assessment: $1,600
    • Storage charges (possibly): $2,180 (if deemed necessary for construction)
  • Machinery and Equipment:
    • Purchase price: $65,000
    • Freight: $1,340
    • Installation: $2,000
    • Hauling charges: $620

The interest of $7,400 during construction is also capitalized and added to the relevant assets. Landscaping costs are added to land improvements or land value, depending on accounting policies.

Conclusion

Appropriate classification and capitalization of these costs provide an accurate reflection of Allegro Supply Company's assets. This ensures compliance with generally accepted accounting principles and provides stakeholders with a truthful view of the company's investments in property, plant, and equipment. Costs such as storage and salvage, which do not contribute directly to the asset's readiness for use, are recognized as expenses or reductions where applicable.

References

  • Financial Accounting Standards Board (FASB). (2016). ASC 360 - Property, Plant, and Equipment.
  • International Financial Reporting Standards (IFRS) Foundation. (2020). IAS 16 - Property, Plant and Equipment.
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