Ramon Manuel, the president of Manuel Manufacturing Company, has e-mailed you to discuss the cost of a new machine that his company has just acquired. The machine was purchased in Montreal for $150,000. Transporting it from Montreal to the company’s factory in Hamilton, Ontario, and installing the machine were Manuel’s responsibilities. Unfortunately, the machine was seriously damaged during this process and repairs costing $40,000 were required to restore it to its original condition. Mr. Manuel wants to ensure that he can capitalize these repair costs as part of the cost of the machine, and has therefore consulted you on the following points as he understands them:
1. The cost of a capital asset should include all the costs that are necessary to get it in place and ready for use. The damaged machine was inoperative, so the repairs were definitely necessary.
2. All the other costs related to the transportation and installation of the machine are being capitalized.
3. An asset is expected to generate economic benefits in the future. Since the repairs have enhanced the machine’s ability to help generate revenues in future period, they have increased the economic benefits that it will provide in future periods. Therefore, the repair costs should be capitalized.
Required:
Discuss how Manuel Manufacturing Company should account for the $40,000 cost of the repairs. Ensure that you explain your reasoning and address each of Mr. Manuel’s arguments in your reply.