Question

Daniel Barenboim sells and erects shell houses, that is, frame structures that are completely finished on the outside but are unfinished on the inside except for flooring, partition studding, and ceiling joists. Shell houses are sold chiefly to customers who are handy with tools and who have time to do the interior wiring, plumbing, wall completion and finishing, and other work necessary to make the shell houses livable dwellings.

Barenboim buys shell houses from a manufacturer in unassembled packages consisting of all lumber, roofing, doors, windows, and similar materials necessary to complete a shell house. Upon commencing operations in a new area, Barenboim buys or leases land as a site for its local warehouse, field office, and display houses. Sample display houses are erected at a total cost of $30,000 to $44,000 including the cost of the unassembled packages. The chief element of cost of the display houses is the unassembled packages, inasmuch as erection is a short, low-cost operation. Old sample models are torn down or altered into new models every 3 to 7 years. Sample display houses have little salvage value because dismantling and moving costs amount to nearly as much as the cost of an unassembled package.

A choice must be made between (1) expensing the costs of sample display houses in the periods in which the expenditure is made and (2) spreading the costs over more than one period. Discuss the advantages of each method.

Would it be preferable to amortize the cost of display houses on the basis of (1) the passage of time or (2) the number of shell houses sold? Explain.

Answer 1

Aus, (a) The preferable treatment of the costs of the sample Display house is expensing them over more than one Period These sample Display houses are assests beca- use they represents rights to future service Potentials or economic benefits. According to the expense recognition Principle, the costs of the service potential should be Amortized as the benefits an received. Thing costs of the sample display houses should be matched with the revenue from the sale of the houses which is receivable over a period of one year. As the sample houses are left on display to 3 to 7 years, Daniel Barenboim apparently expects to benefit from the display for at least that laugth of time, more than The alternative of expeusing the costs of sample display houses in the period in which the expenditure is made is based primarily upon the exfeuse recognition Principle- These costs are of a promotional Matine, Domotional costs offen are considered expenses of the Peried in which the expenditure. oclur due to the uncertainty in defermining the time periods benefited. It is likely that no decision is made concerning the life of a sampe display house at the time it is erected Post experiance may provide some guidance in determining the probable life. A decision to tear down or alter

a house probably is made when sales begin to lag or when a new model with greater Petential becomes available. There is uncertainty not only as to the life of a sa riple display house but also as to whether sample display house will be torn down or altered If it is altered rather than dom down, a Portion of the lost of the original house may be attributable to the new model. on the (b) If all of the the Shell houses are to be sold at the same frice, It may be also priate to to alle cate would be sinitar the cests of the of the display display houses basis of the number of shell houses sold. This allo- cation would be similar to the veits of Production method of depreciation and would result in a good Matching of costs with Revenues, On the other hand, If the swell houses are to be sold at different Prices It may be preferable to allocate cests on the basis of the Revenue contribution of the shell houses sold. uncertainty regarding the number f hores of a particular model which will be sold as a result of the display sample. The sucess of this amortization method is dependent upou Acerrate estimates of the number and selling price of the shell houses to be sold . The estimates of the number of wits of 1 There is

a result of a a particular model which will be sold display Model should include. Not only with sold while the model is on display but also writs sold after the display house is form down or alterned. Cost Amortization solely on the basis of time may be forferable when the esfe of the Models can be es tirated with a great deal amore accuracy cash then Can the wember of writs which will be sold. If sales and selling prices are uniforory over the life of the sample, Satisfactory matching of costs and Renciues may be actor achieved epof the straight line amortization procedure is used.