Cost of Machinery

When machinery is purchased, the cost normally includes the following:

a. Purchase Price
b. Freight, handling, storage and other cost related to the acquisition
c. Insurance while in transit
d. Installation cost, including site preparation and assembling
e. Cost of testing and trial run, and other cost necessary in preparing the
machinery for its intended use.
f. Initial estimate of cost of dismantling and removing the machinery and
restoring the site on which it is located, and for which the entity has a
present obligation.
g. Fee paid to consultants for advice on the acquisition of the machinery
h. Cost of safety rail and platform surrounding machine.
i. Cost of water device to keep machine cool.
 If the machinery is moved to a new location, the undepreciated cost of the

old installation cost is expensed and the new installation cost is charged to

the new asset.

 If the machine is removed and retired to make room for the installation of a

new one , the removal cost not previously recognized as a provision is

charged to expense.

 The value added tax or VAT on the purchase of machinery is not

capitalizable but charged to input tax to be offset against output tax.

 However, any irrecoverable purchase tax is capitalized as cost of the

machinery.
Tools
 Tools are classified as machine tools and
hand tools. Machine tools are those used in
connection with the operation of the
machine. Examples are drills and punches.

 Hand tools are those not used in operating

the machine. Examples of hand tools are
hammer and saws. Tools should be
segregated from the machinery account.
Patterns and Dies
Patterns and dies are those used in
designing or forging out a particular
product. If patterns and dies are used for the
regular products of the company, they are
recorded as assets.
Patterns and dies are depreciated over their
useful life.

However, if the patterns and dies are used for

specially ordered products, they are
expensed outright and form part of the cost
of the special product.
Equipment
The term “equipment” includes delivery equipment,
store equipment, office equipment, and furniture and
fixtures.

The cost of such assets includes the purchase price,

freight and other handling charges, insurance while in
transit, installation costs and other costs necessary in
preparing them for the intended use.

Delivery equipment includes cars, trucks and other

vehicles used in business operations.
Motor vehicle registration fees should be expensed and
not be included as part of the cost of the delivery
equipment.
Store and office equipment include computers,
typewriters, adding machines, cash registers,
calculators and similar assets.
If the assets are identified with the selling function,
they are classified as store equipment, otherwise they
are charged to office equipment.

Furniture and fixtures include showcases, counters,

shelves, display fixtures, cabinets, partitions, safes,
desks, tables and similar items.

In broad sense, furniture and fixtures may include

store and office equipment.
Returnable containers
Returnable containers include bottles, boxes, tanks, drums
and barrels which are returned to the seller by the buyer
when the contents are consumed or used.

Containers in big units or of great bulk as in the case of tanks,

drums and barrels are classified as property, plant and
equipment.

On the other hand, containers that are small and individually

involve small amount as in the case of bottles and boxes
are classified as other noncurrent assets.

Needless to say, containers that are not returnable are

charged outright to expense.
Capital expenditure and revenue expenditure

An expenditure that benefits only the current period is a

revenue expenditure and therefore reported as an
expense.

An expenditure that benefits the current period and future

periods is a capital expenditure and therefore reported as
an asset.
Recognition of subsequent cost
The recognition of subsequent cost is subject to the same
recognition criteria for the initial cost of property, plant and
equipment.

Accordingly, the subsequent cost incurred for property, plant and

equipment shall be recognized as an asset when:

a. It is probable that future economic benefits associated with

the subsequent cost will flow to the entity.
b. The subsequent cost can be measured reliably.

In other words, if the subsequent cost will increase the future

service potential of the asset, the cost should be capitalized.
If the subsequent cost merely maintains the existing level of
performance, the cost should be expensed when incurred.
Future economic benefit
In general, a subsequent cost on an item of property, plant
and equipment will benefit future periods or increase the
future service potential of an asset when:

a. The expenditure extends the life of the property.

b. The expenditure increases the capacity of the property
and quality of output, for example, by upgrading machine
parts.
c. The expenditure improves the efficiency and safety of the
property, for example, by adopting a new production
process leading to large reduction in operating cost.
Subsequent cost
Generally, the following expenditures are incurred during
ownership of existing property, plant and equipment.

a. Additions
b. Improvements or betterments
c. Replacements
d. Repairs
e. Rearrangement cost
Additions
Additions are modifications or altercations which increase the
physical size or capacity of the asset. Such expenditures are of
two types, namely:
a. An entirely new unit.
b. An expansion, enlargement or extension of the old asset.

The construction of new building is an addition of the first type but

the addition of a wing to a building or the construction of a third
storey on a two-storey building is an addition of the second type. In
either case, the cost is capitalized in the usual manner.

The cost of an addition which is a new unit is depreciated over the

useful life.
But the cost of an expansion should be depreciated over the useful
life of the expansion or remaining useful life of the asset of which it
is part whichever is shorter.
Improvements or betterments
Improvements or betterments are modifications or alternations which
increase the service life or the capacity of the asset.

Improvements may represent replacement of an asset or part thereof

with one of a better or superior quality. Such expenditures are
normally capitalized.

The improvements that do not involve replacement of parts are simply

added to the cost of the existing asset.

Examples of improvements are:

a. A tile roof is substituted for wooden shingles

b. A shatter proof glass is substituted for ordinary glass.
c. An old motor in a machine is replaced by a new and powerful one.
d. Galvanized iron roofing is substituted for nipa roofing.
e. Replacement of wooden floor by concrete flooring.
Replacements
Replacements also involve substitution but the new asset is not
better than the old asset when acquired.

The basic difference between an improvement and replacement is

that an improvement is a substitution of a better or superior
quality whereas a replacement is a substitution of an equal or
lesser quality.

Replacements may be classified into three:

a. Replacement of the old asset by a new one. This is the
replacement contemplated.
For example, an old truck is replaced by a new one. This
replacement is surely capitalized as a new asset.

b. Replacement of major parts or extraordinary repairs.

c. Replacement of minor parts or ordinary repairs.
Repairs
Repairs are those expenditures used to restore assets to good
operating condition upon their breakdown or replacement of
broken parts.

Repairs may be classified as extraordinary repairs and ordinary

repairs.

Extraordinary repairs are material replacement of parts, involving

large sums and normally extend the useful life of the asset.

Extraordinary repairs are usually capitalized.

Ordinary repairs are minor replacement of parts, involving small

sums and are frequently encountered.
Ordinary repairs are normally charged to expense when incurred.
Accordingly, an entity does not include in the carrying
amount of property, plant and equipment the cost
of day-to-day servicing of the property.

Rather, such cost of day-to-day servicing is

recognized as expense when incurred.
Repair and maintenance
Repair is different from maintenance in that repair restores the
asset in good operating condition while maintenance keeps
the asset in good condition.

Thus, repair is restorative or curative while maintenance is

preventive.

The theoretical distinction is difficult to maintain in practice

hence the two are combined in a single account “repair
and maintenance.”
Rearrangement cost
Rearrangement cost is the relocation or reinstallation of an asset
which proves to be less efficient in the original location.

The rearrangement normally increases the future service potential of

the asset and therefore the rearrangement cost should be
capitalized.

For example, the rearrangement of a group of machines increases

the future service potential of the machines because the
rearrangement:
a. Facilitates future production
b. Secures greater efficiency
c. Achieves substantial reduction in previously assessed operating
cost
However, if the rearrangement merely maintains the existing level of
performance of the asset, the rearrangement cost should be
expense immediately
Accounting for major replacement
An important consideration in determining the appropriate accounting
treatment for a replacement is whether the original part of an
existing asset is separately identifiable.

If separate identification is practicable, the major replacement is

debited to the asset account.

The cost of the part eliminated and the related accumulated

depreciation are moved from the accounts and the remaining
carrying amount of the old part is treated as a loss.

If it is not practicable for an entity to determine the carrying amount

of the replaced part, it may use the cost of the replacement as
an indication of the “likely original cost” of the replaced part at the
time it was acquired or constructed.

However, the current replacement cost shall be discounted.