Question

Two positions have normally been taken with respect to the recording of fixed manufacturing overhead as an element of the cost of plant assets constructed by a company for its own use: (a) It should be excluded completely. (b) It should be included at the same rate as is charged to normal operations. What are the circumstances or rationale that support or deny the application of these methods

Answer 1

Answer:

Recording fixed manufacturing overhead as element of the cost of plant assets constructed by a company for its own use:

a) When to exclude completely: During periods of low production activity, capitalization of fixed overhead costs would reduce the amount assigned to operational activities.  This implies that profits will be overstated in some periods and understated in others.

b) When to include at the same rate as is charged to normal operations:  To avoid misstatement of both plant assets and finished goods, it is important to allocate overhead costs at the same rate to plant asset construction as is done for normal operations.

Explanation:

Much of the fixed manufacturing overhead will be the depreciation costs for factory building and equipment.  Sometimes, companies construct their plant assets internally.  The problem arises when deciding whether to allocate fixed manufacturing overhead costs or not and  when to allocate.  The decision requires some thinking to decide when it is appropriate.