Problem:
Jay Manufacturing, Inc. began operations five years ago producing probos, a new type of instrument it hoped to sell to doctors, dentists, and hospitals. The demand for probos far exceeded initial expectations, and the company was unable to produce enough probos to meet that demand. The company was manufacturing probos on equipment it built at the start of its operations, but to meet demand more efficient equipment was needed. Company management decided to design and build the equipment because equipment that was currently available on the market was unsuitable for producing probos.
In 2006 a section of the plant was devoted to development of the new equipment and a special staff of personnel was hired. Within six months a machine was developed at a cost of $170,000 that increased production and reduced labor cost substantially. Sparked by the success of the new machine, the company built three more machines of the same type at a cost of $80,000 each.
Required:
Q1. In addition to satisfying a need that outsiders cannot meet within the desired time, what other reasons might cause a firm to construct fixed assets for its own use?
Q2. In general, what costs should be capitalized for a self-constructed asset?
Q3. Discuss the proprietary (give pros and cons) of including in the capitalized cost of self-constructed assets:
i. The increase in overhead caused by the self-construction of fixed assets.
ii. A proportionate share of overhead on the same basis as that applied to goods manufactured for sale. Take into consideration whether or not the company is at full capacity.
Q4. Discuss the proper accounting treatment of the $90,000 ($170,000 - $80,000) by which the cost of the first machine exceeded the cost of the subsequent machines.