Accounting for Long-term Assets

8.1.2 Historical cost of fixed assets

All assets are recorded at their historical cost.

A historical cost includes the purchase price and any additional costs necessary to obtain the asset and prepare it for the intended use. Additional costs (costs besides the purchase price) may include transportation costs, insurance for asset delivery and others.

The following are some costs usually included in the historical cost of an asset:

Purchase of a building: purchase price, title search and transfer documents, real estate fees, and remodeling costs.
Purchase of equipment: purchase price, delivery costs, installation, and costs for modifications to prepare the asset for intended use.
Purchase of land: purchase price, removal of old buildings, title search and transfer documents, and real estate fees.

There are a number of expenditures that cannot be included into the cost of an asset. Such expenditures include payments for fines, damages, and so on, which are not considered normal costs of acquiring an asset.

8.1.3 Lump sum acquisitions of fixed assets

Sometimes a company buys several assets for a lump sum. The total of market values of individual assets included in the purchase may be greater than the total price paid by the company. Such a purchase is called a basket purchase. The company must determine how much of the total price should be assigned to each asset. This can be done by using the relative fair market method. Look at the example below.

Suppose, Nokle's Company acquired a machine and related tooling by paying $600. The asset market values, provided they were acquired separately, are $700 and $300 respectively. So, the total fair market value is $1,000 ($700 +$300). We can see that the machine is worth 70% ($700 / $1,000 x 100%), and the tooling is worth 30% ($300 / $1,000 x 100%) of the price paid. By applying these percentages, we can calculate the cost of each asset as shown below:

Illustration 8-1: Allocation of the purchase price in a basket purchase

Machine	70% x $600 = $420
Tool	30% x $600 = $180
Total	$600

8.2 Depreciation as a means of fixed assets cost allocation

When an asset is acquired, its cost is not expensed at the acquisition time because the asset is used for more than a year. Instead, the asset cost is allocated over its useful life. In another lesson we have seen how the straight-line method is applied. This method is appropriate when an asset is used evenly over its useful life. However, some assets can be used more extensively during their first years of operation. Other assets are used more during one year, but less during another year, and so on. This kind of assets requires accelerated depreciation methods, which charge more of the assets costs in the years of their more extensive use.

To demonstrate application of different depreciation methods, let us look at the following example. A computer science graduate student decided to start his own business. The student, Mr. Serfy, will develop software for small businesses. In order to create reliable products, Mr. Serfy acquired a computer that cost $23,000 in 20X7. The computer is expected to have a salvage value of $3,000 and a 4-year useful life. Mr. Serfy has made predictions that the revenue stream will be $9,000 per year.

8.2.1 Straight-line method of depreciation

Provided that the revenue will remain the same each year, it is reasonable to employ straight-line depreciation method.

Straight-line depreciation is a depreciation method in which periodic depreciation is the same for each period of the asset useful life.

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