Gomi Medical Labs Inc. began operations five years ago producing a new type of instrument it hoped to sell to doctors, dentists, and hospitals. The demand for the new instrument was much higher than had been planned for, and the company was unable to produce enough of them to meet demand. The company was manufacturing its product on equipment that had been built at the start of its operations.

To meet demand, more efficient equipment was needed. The company decided to design and build the equipment because the equipment currently on the market was unsuitable for producing this product.

In 2020, a section of the plant was devoted to developing the new equipment and expert employees were hired. Within six months, a machine, developed at a cost of $714,000, increased production dramatically and reduced labour costs substantially. Thrilled by the new machine’s success, the company built three more machines of the same type for its own use, at a cost of $441,000 each.

Instructions

a. In general, what costs should be capitalized for self-constructed equipment?

b. Discuss whether the capitalized cost of self-constructed assets should include the following:

1. The increase in overhead that results from the company’s own construction of its fixed assets

2. A proportionate share of overhead on the same basis as what is applied to goods that are manufactured for sale

c. Discuss the proper accounting treatment of the $273,000 cost amount ($714,000 – $441,000) that was higher for the first machine than the cost of the subsequent machines.