Question

Purchase of a Vineyard Your client has just purchased land on which it intends to build a vineyard. In doing so, the client incurs the following costs:

1) land surveys;

2) costs of leveling the land;

3) installation of fencing;

4) installation of a sprinkler system.

Refer to industry guidance in the Codification to determine whether these costs should be capitalized and whether there are restrictions surrounding the capitalization period. Also, educate your client on how the Codification classifies these different types of costs. Finally, locate one other example of a cost that may be capitalized and explain any restrictions on the period during which the cost may be capitalized.

Answer 1

A capitalized cost is an expense that is added to the cost basis of a fixed asset on a company's balance sheet. Capitalized costs are incurred when building or purchasing fixed assets. Capitalized costs are not expensed in the period they were incurred but recognized over a period of time via depreciation or amortization.

• With capitalized costs, the monetary value isn’t leaving the company with the purchase of an item, as it is retained in the form of a fixed or intangible asset.
• Capitalized costs are depreciated or amortized over time instead of being expensed immediately.
• The purpose of capitalizing costs is to better line up the cost of using an asset with the length of time in which the asset is generating revenue.
• When capitalizing costs, a company is following the matching principle of accounting. The matching principle seeks to record expenses in the same period as the related revenues. In other words, the goal is to match the cost of an asset to the periods in which it is used, and is therefore generating revenue, as opposed to when the initial expense was incurred. Long-term assets will be generating revenue over the course of their useful life. Therefore, their costs may be depreciated or amortized over a long period of time.

For example, expenses incurred during construction of a warehouse are not expensed immediately. The costs associated with building the warehouse, including labor costs and financing costs, can be added to the carrying value of the fixed asset on the balance sheet. These capitalized costs will be expensed through depreciation in future periods, when revenues generated from the factory output are also recognized.

Assume the warehouse in the above example was a coffee roasting facility. Some of the likely costs of building and operating a roasting facility are customization of the interior for the specifics of the business, purchase of roasting and packing equipment, and equipment installation costs. In addition to the machinery and hardware, the company would need to purchase green coffee (inventory) to roast. It also needs to pay its employees to roast and sell that coffee. Further costs would include marketing and advertising their product, sales, distribution, and so on.These expenses written off on Profit & Loss account in the same year .

The roasting facility’s packaging machine, roaster, and floor scales would be considered capitalized costs on the company’s books. The monetary value isn’t leaving the company with the purchase of these items. When the roasting company spends $40,000 on a coffee roaster, the value is retained in the equipment as a company asset. The price of shipping and installing equipment is included as a capitalized cost on the company’s books. The costs of a shipping container, transportation from the farm to the warehouse, and taxes could also be considered part of the capitalized cost. These expenses were necessary to get the building set up for its intended use.

so client should capitalized the following expenses as these expenses cannot be written off as an expense in the same year as these expenses increase the life of assets.

1) land surveys;

2) costs of leveling the land;

3) installation of fencing;

4) installation of a sprinkler system.

In accounting, the cost of an item is allocated to the cost of an asset, as opposed to being an expense, if the company expects to consume that item over a long period of time. Rather than being expensed, the cost of the item or fixed asset is capitalized and amortized or depreciated over its useful life.

o capitalize cost, a company must derive economic benefit from assets beyond the current year and use the items in the normal course of its operations. For example, inventory cannot be a capital asset since companies ordinarily expect to sell their inventories within a year.

Because capitalized costs are depreciated or amortized over a certain number of years, their effect on the company's income statement is not immediate and, instead, is spread out throughout the asset's useful life. Usually, the cash effect from incurring capitalized costs is immediate with all subsequent amortization or depreciation expenses being non-cash charges.