In this article we will discuss about the problems relating to accounting for long-term assets.
First, what is the original acquisition cost of a particular long-term asset.
Second, how should the amount of expense or period write off should be determined and allocated against yearly revenue to reflect the asset’s consumption.
The other related issues are how should subsequent expenditures such as repairs, maintenance and additions be treated, how should disposal of long-term assets be recorded. These accounting problems are graphically presented in Figure 8.1.
For accounting purposes, the acquisition cost of a long-term asset having a limited useful life indicates the prepaid cost of a bundle of future services or benefits that will help earn future revenues. Acquisition cost of long-term assets are like inventories and prepaid expenses. Acquisition cost includes all expenditures necessary to get the long-term assets in place and ready for use.
Cost of a long-term asset is easy to determine when the asset is purchased for cash. In this case, cost of asset is equal to cash paid for the asset plus expenditures for freight, insurance while in transit, sales tax, special foundations, installation and other necessary costs. When a second hand asset is purchased, the initial costs of getting it ready for use, such as expenditures for new parts, repairs and painting are added to the cost of assets.
Some costs associated with the acquisition of an asset are not added to the cost of asset, if they are found not necessary to get the asset ready for use and therefore, do not increase asset’s usefulness. Expenditures resulting from carelessness or errors in installing the asset, from vandalism or from other unusual occurrences do not increase the usefulness of the assets and should be treated as expenses.
If a debt is incurred for the purchase of the asset, the interest charges are not the cost of the asset but are the cost of borrowing money to purchase the asset. They are, therefore, an expense for the period. But interest incurred during the construction period of an asset are treated as part of the cost of an asset.
The cost of land includes not only the negotiated price but also other expenditures such as broker’s commissions, title fees, surveying fees, Lawyer’s fees, accrued taxes paid by the purchaser, assessment for local improvements such as streets and sewage systems, cost of draining, clearing, leveling, and grading Any salvage recorded from the old building will be deducted from the cost of the land.
Improvements to land such as parking lots, private side-walks, driveways, fences are note added to the cost of land but to a separate account, Land Improvement Account. These expenditures are depreciated over the estimated lives of the improvements.
When an existing or old building or used machinery is purchased, its cost includes the purchase price plus all repair, renovation and other expenses incurred by the purchaser prior to use of asset. Ordinary repair costs incurred after the asset is placed in use are normal operating expenses when incurred.
When a business constructs its own buildings, the cost includes all reasonable and necessary expenditures such as those for materials, labour, some related overhead and indirect costs, architects’ fees, insurance during construction, interest on construction loans during the period of construction, lawyer’s fees. If outside contractors are used in the construction, the net contract price plus other expenditures necessary to put the building in usable condition are included.
Sometimes, basket purchases (also known as group purchases, package purchases) of assets are made by the purchaser wherein two or more types of long-term assets are acquired in a single transaction and for a single lump-sum. In basket or package purchases, cost of each asset acquired must be measured and recorded separately.
For example, assume that a purchaser has purchased land and the building situated on the land for a lump-sum payments of Rs. 8.50,000. The total purchase price can be divided between these two assets on the basis of relative market or appraisal values, as shown below.
When a long-term asset is purchased and a non-cash consideration is included in part or in full payment for it, the cash equivalent cost is measured as any cash paid plus current market value of the non-cash consideration given. Alternatively, if the market value of the non-cash consideration given cannot be determined, the current market value of the asset purchased is used for measurement purposes.
As a general rule, long-term assets are recorded at cost due to the basic criterion of objectivity. However, there could be some exceptions to this rule of cost basis. For example, if an asset acquires an asset by donation or pays substantially less than the market value of the asset, the asset is recorded at its fair market value.
Similarly, if the value of land increases sharply after its acquisition due to some abnormal factors such as discovery of mineral deposits or oil, the amount originally recorded as the cost of land may be increased to reflect current value of the land.