Components of Asset Cost



Cost of Land

Land is recognized at its historical cost or purchase price, and can include any other related initial costs spent to put the land into use.

Learning Objectives

Describe how land is reported on the financial statements

Key Takeaways

Key Points

  • Land is defined as the ground the company uses for business operations; it includes ground on which the company locates its headquarters or land used for outside storage space or as a parking lot.
  • Unlike a majority of fixed assets, land is not subject to depreciation.
  • Land is listed on the balance sheet under the section for non-current assets. Increases in market value are disregarded on the balance sheet.
  • At time of sale, the difference between a land’s market value and historical cost is recognized as a gain or loss on the income statement.

Key Terms

  • balance sheet: A balance sheet is often described as a “snapshot of a company’s financial condition. ” A standard company balance sheet has three parts: assets, liabilities, and ownership equity.
  • income statement: Displays the revenues recognized for a specific period and the cost and expenses charged against these revenues, including write-offs (e.g., depreciation and amortization of various assets) and taxes. The purpose of the income statement is to show managers and investors whether the company made or lost money during the reporting period.

Land and Historical Cost

Land is defined as the ground occupied by a business’ operations. This can include a company’s headquarters, outside storage space or the company’s parking lot.

Land is recognized at its historical cost, or the cost paid to purchase the land, along with any other related initial costs spent to put the land into use.

Land is a type of fixed asset, but unlike a majority of fixed assets, it is not subject to depreciation.

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The cost of land is based on its acquisition price.: All costs associated with acquiring land and putting it to use are included in the cost of land.

Land on the Balance Sheet

Land is listed on the balance sheet under the section for long-term or non-current assets. If the land’s market value increases over time, its value on the balance sheet remains at historical cost.

For example, land purchased in 1988 for $90,000, would still appear on the December 31, 2010 balance sheet at $90,000, even though its market value is now $300,000. This is based on the assumption that land is acquired for business use and not as an asset held for sale.

Sale of Land

If at a future date the land is sold due to a business relocation or other reason, the difference between the land’s market value and its historical cost will result in a gain or loss disclosed on the income statement. If the sale of land results in a gain, the additional cash or value received in excess of historical cost will increase net income for the period. If the sale results in a loss and the business receives less than the land’s historical cost, the loss will reduce net income for the period.

Cost of Buildings

The cost of a building is its original purchase price or historical cost and includes any other related initial costs.

Learning Objectives

Summarize how a company would calculate the cost of a building

Key Takeaways

Key Points

  • Buildings are listed at historical cost on the balance sheet as a long-term or non-current asset.
  • Buildings are subject to depreciation or the periodic reduction of value in the asset that is expensed on the income statement and reduces net income.
  • Since buildings are subject to depreciation, their cost is adjusted by accumulated depreciation to arrive at their net carrying value on the balance sheet.
  • If at a future date a building is sold, any gain or loss on the sale is based on the difference between the building’s net carrying value and the market sales price.

Key Terms

  • Accumulated Depreciation: Accumulated depreciation is known as a contra account, because it separately shows a negative amount that is directly associated with another account.

Buildings and Historical Cost

A building is an asset used for commercial purposes and includes office buildings, warehouses, or retail establishments (i.e., convenience stores, “big box” stores, shopping malls, etc.). The cost of a building is its original purchase price or historical cost and includes any other related initial costs spent to put it into use. Similar to land, buildings are also a type of fixed asset purchased for continued and long-term use in earning profit for a business. Unlike land, buildings are subject to depreciation or the periodic reduction of value in the asset that is expensed on the income statement and reduces income. They also can incur substantial maintenance costs, which are expensed on the income statement and reduce an accounting period’s income.

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The cost of a building can include construction costs and other costs incurred to put the building into use.: Delays in construction can effect the total cost of a building.

Buildings on the Balance Sheet

Buildings are listed at historical cost on the balance sheet as a long-term or non-current asset, since this type of asset is held for business use and is not easily converted into cash. Since buildings are subject to depreciation, their cost is adjusted by accumulated depreciation to arrive at their net carrying value on the balance sheet. For example, on Acme Company’s balance sheet, their office building is reported at a cost of $150,000, with accumulated depreciation of $40,000. The building’s net carrying value or net book value, on the balance sheet is $110,000.

Sale of Buildings

If at a future date a building is sold due to a business relocation or other reason, any gain or loss on the sale is based on the difference between the building’s net book value and the market sales price. If the sale results in a gain, the excess received over the building’s net book value is disclosed on the income statement as an increase to the accounting period’s income. If the sale results in a loss and the business receives less than book value, the loss is also disclosed on the income statement as a decrease to income.

Cost of Equipment

The cost of equipment is the item’s purchase price, or historical cost, plus other initial costs related to acquisition and asset use.

Learning Objectives

Describe how a company calculates the cost of a piece of equipment

Key Takeaways

Key Points

  • Fixed assets are long term items such as property plant or equipment.
  • Equipment is listed on the balance sheet at its historical cost amount, which is reduced by accumulated depreciation to arrive at a net carrying value or net book value.
  • Selling equipment triggers a gain or a loss, depending on the difference between the equipment’s net book value and its sale price.

Key Terms

  • International Accounting Standard: accounting rules that are a part of IFRS (International Financial Reporting Standards), a common global language for business affairs so that company accounts are understandable and comparable across international boundaries.
  • property, plant, and equipment: an accounting term for certain fixed assets and property which will be used for a long period of time, such as land, machinery, and factories
  • book value: the value is based on the original cost of the asset less any depreciation, amortization or Impairment costs made against the asset.

Equipment and Historical Cost

Fixed assets, also known as non-current or tangible assets, include property, plant, and equipment. Fixed assets, according to International Accounting Standard (IAS) 16, are long range assets whose cost can be measured reliably.

The equipment’s cost is calculated by adding the item’s purchase price, or historical cost, to the other costs related to acquiring the asset. These additional costs can include import duties and deductible trade discounts and rebates.

Historical cost also includes delivery and installation of the asset, as well as the dismantling and removal of the asset when it is no longer in service. Equipment is subject to depreciation. Depreciation is a periodic reduction in an asset’s value. It is disclosed on the income statement and appears as a contra-asset account on the balance sheet.

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The cost of equipment includes all costs paid to put the asset into use.: Equipment is listed in a separate section within the balance sheet.

Equipment and the Balance Sheet

Since accounting standards state that an asset should be carried at the net book value, equipment is listed on the balance sheet at its historical cost amount. The cost is then reduced by accumulated depreciation to arrive at a net carrying value or net book value. A company is free to decide what depreciation method to use on the equipment.

Sale of Equipment

When an equipment is sold, the sale of the asset can trigger a gain or a loss, depending on the difference between the equipment’s net book value and its sale price. As with other assets, gain or losses on sales of equipment are disclosed on the income statement as a reduction or addition to income for the period.

Cost of Improvements

The cost of an asset improvement is capitalized and added to the asset’s historical cost on the balance sheet.

Learning Objectives

Describe how a company would account for costs associated with improving an asset

Key Takeaways

Key Points

  • Asset improvements are undertaken to enhance or improve a business asset that is in use.
  • Since the cost of the improvement is capitalized, the asset’s periodic depreciation expense will be affected (increased).
  • If the asset improvement is financed, the interest cost associated with the improvement should not be capitalized as an addition to the asset’s historical cost.
  • Depending on the nature of the improvement, it also is possible that the asset’s useful life and salvage value may change as a result of the enhancements.
  • Note the difference between an improvement (capitalized) and a maintenance charge (expensed) from a reporting perspective.

Key Terms

  • cost principle: assets should always be recorded at their purchase price
  • capital improvements: Activities directed towards expanding the capacity of an asset or otherwise upgrading it to serve needs different from, or significantly greater than, its current use.
  • historical cost: The original monetary value of an economic item and based on the stable measuring unit assumption. Improvements may be added to an asset’s cost.

Capitalization of Asset Improvements

Asset or capital improvements are undertaken to enhance or improve a business asset that is in use. The cost of the improvement is capitalized and added to the asset’s historical cost on the balance sheet. Since the cost of the improvement is capitalized, the asset’s periodic depreciation expense will be affected, along with other factors used in calculating depreciation. Capital improvements should not be confused with regular maintenance expenses to maintain an asset’s functionality, which are regarded as period costs that are expensed on the income statement and reduce income for the period.

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An example of an asset improvement can be the addition of a logo to a delivery truck.: The cost of the improvement adds value to the asset.

Financing Improvements

If the capital improvement is financed, the interest cost associated with the improvement should not be capitalized as an addition to the asset’s historical cost. Interest costs are not capitalized for assets that are not under construction. For example, Acme Company decides to add the company’s logo to their delivery trucks and takes out a $5,000 loan. In 201X, the interest expense is $50; the interest expense is a period cost and reported on the income statement for 201X and not added to the asset’s historical cost.

Asset Improvements and Depreciation

When the cost of a capital improvement is capitalized, the asset’s historical cost increases and periodic depreciation expense will increase. Depending on the nature of the improvement, it is also possible that the asset’s useful life and salvage value may change as a result. The change in periodic depreciation expense also can be impacted by the method used to calculate depreciation and may also have federal income tax consequences.

Asset Improvement vs. Maintenance

Asset improvements are capitalized and reported on the balance sheet because they are for expenses that will provide a benefit beyond the current accounting period. For example, costs expended to place the company logo on a delivery truck or to expand the space on a warehouse would be capitalized because the value they provide will extend into future accounting periods. Maintenance costs are expensed and reported on the income statement as a reduction to current revenues because they provide a benefit in the current accounting period and should be matched with the revenues earned during this period. Examples of expensed costs include payment of regular service maintenance on equipment and machinery.

Cost of Interest During Construction

The amount of interest cost incurred and/or paid during an asset’s construction phase is part of an asset’s cost on the balance sheet.

Learning Objectives

Explain how a company records interest on a construction loan

Key Takeaways

Key Points

  • The cost of interest incurred and/or paid is included as part of the historical cost of the asset under construction. No separate line item is needed on the balance sheet.
  • The asset under construction should be intended for the generation of company earnings and should not be retail inventory or inventory held for sale.
  • Do not capitalize interest costs during delays in the construction phase.
  • When the asset’s construction is complete and the asset is ready for use, any additional interest expense incurred is no longer capitalized as part of the asset’s cost.

Key Terms

  • capitalization: The act of calculating the present value of an asset.
  • inventory: A detailed list of all of the items on hand.

Capitalizing Interest Costs

Interest is defined as a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds. When an asset is constructed, a company typically borrows funds to finance the costs associated with the construction. The amount of cash borrowed will incur interest expense to the borrower; the interest paid by the borrower serves as interest income to the lender. The capitalization of interest costs involves adding the amount of interest expense incurred and/or paid during the asset’s construction phase to the asset’s cost recorded on the balance sheet. The asset’s intended use should be for the generation of company earnings. Interest cost capitalization does not apply to retail inventory constructed or held for sale purposes.

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Most of the interest paid during construction is part of an asset’s cost.: Interest paid during delays in construction is excluded from the asset’s cost.

Interest Costs on the Balance Sheet

The cost of interest incurred and/or paid is included as part of the historical cost of the asset under construction. No separate line item is needed on the balance sheet to disclose the interest costs associated with the asset. If any delays occur during the construction phase, the interest costs incurred during the delay are not capitalized. This interest cost is recorded as interest expense and reported as a period cost on the income statement rather than the balance sheet.

Interest Costs After Construction

When the asset’s construction is complete and the asset is ready for use, any additional interest expense incurred is no longer capitalized as part of the asset’s cost. This interest is expensed on the income statement and reduces income for the accounting period.