Self Constructed Assets

Explore the intricate world of business studies as you delve into the fundamental understanding of Self Constructed Assets. Decipher its definition, importance and main characteristics. Subsequently, expand your knowledge with insightful details on the accounting process for these assets, including key steps and the role of GAAP. Learn about the capitalisation of Self Constructed Assets and acquaint yourself with global understandings, including those under GAAP and IFRS. Finally, solidify your learning through real-life practical examples and case studies. This comprehensive guide on Self Constructed Assets provides essential instructions and insights for anyone interested in Business Studies.

Get started

Millions of flashcards designed to help you ace your studies

Sign up for free

Review generated flashcards

Sign up for free
You have reached the daily AI limit

Start learning or create your own AI flashcards

StudySmarter Editorial Team

Team Self Constructed Assets Teachers

  • 19 minutes reading time
  • Checked by StudySmarter Editorial Team
Save Article Save Article
Contents
Contents
Table of contents

    Jump to a key chapter

      Understanding Self Constructed Assets in Business Studies

      The subject of self constructed assets can be a little daunting to first time learners in business studies, but they are essential in the accounting and financial fields.

      Fundamental Concepts of Self Constructed Assets

      The premise of self constructed assets is intrinsic to businesses and their financial operations. But to uncover what these assets are, let's delve further into this business phenomena.

      Self Constructed Assets refer to assets that are built or manufactured by a company for its use, as opposed to being bought from another enterprise. This involves expenses and activities related to the production and development of these particular assets.

      These assets might include office buildings, machinery, or software systems developed in-house. The cost of the self constructed assets consists of both direct and indirect costs.

      • Direct costs: These costs can be directly associated with the production of the assets. For example, cost of raw materials, direct labour, etc.
      • Indirect costs: These costs are not directly associated with production but are still needed for the creation of the asset. This includes costs such as depreciation, factory overhead, etc.

      The process of deciding which costs to include in the value of self constructed assets can be complex, as it requires an understanding of both the nature of the costs and the specific accounting standards applicable to the company.

      Definition and Importance of Self Constructed Assets

      Self constructed assets could be referred to as 'internally developed assets'.

      Self constructed assets are essential for companies as they can help in cost saving compared to purchasing similar assets from outside. Often considered a long-term investment, these assets can significantly influence a business's financial health in the longer run.

      They help in minimizing operational costs, enhancing financial resource utilization and allow businesses to tailor them according to their specific needs. Therefore, proper recording and management of these assets should be a priority for any business.

      Main Characteristics of Self Constructed Assets

      The self constructed assets have some unique characteristics that set them apart from other types of assets:

      Unique Specifications: Being manufactured by the company itself, these can be customized fully, according to the company's requirements.
      Investment Source: The funding for these assets primarily comes directly from the company’s capital.
      Control Over Production: As the company is both the creator and user, it has complete control over the production process.
      Impact on Financial statements: These assets significantly influence the balance sheet, income statement and cash flow statement.

      Being aware of these characteristics provides businesses comprehensive insights about the impact, risks, benefits, and functions related to self constructed assets.

      Accounting for Self Constructed Assets

      Unravelling the intricacies of accounting for self constructed assets presents a dynamic challenge which requires your understanding of the basic principles of finance, cost-accounting, and a sound knowledge of related accounting standards. Let's delve deeper into this attribute, which is an integral part of business studies.

      Exploring the Accounting Process for Self Constructed Assets

      Self constructed assets require meticulous accounting as they directly impact a company's financial statements. While resources like raw materials and labour are consumed during the creation of these assets, these costs are technically not 'expenses' in the traditional sense. Instead, they increase the value of the asset under construction, and so, must be capitalised.

      The capitalisation of costs is based on the concept that these costs provide benefits beyond the current period and must therefore be matched to income of later periods.

      Crucially, aligning with the matching principle in accounting, the costs of a self constructed asset should be capitalised until the asset is substantially complete and ready for use. Among these, direct costs such as material and labour costs and those indirect costs that are directly attributable to the asset’s production are considered.

      MOvevover, note that it is not every indirect cost that should be capitalised. According to accounting standards, only those indirect costs that increase during the construction period due to the construction effort should be capitalised. The logic behind this is that these increased costs would not have been incurred if the asset was not being constructed.

      The general formula for the cost of self constructed assets is as follows:

      \[ \text{Cost of Self Constructed Assets} = \text{Direct Materials} + \text{Direct Labour} + \text{Allocated Overheads} \]

      Say a company is constructing a new office building. The cost of cement, bricks, glass and other raw materials represent the direct material costs. Salaries paid to the construction crew represent direct labour costs. While the rent of the construction equipment and other factory overheads like insurance and utilities used during the construction period will be counted as allocated overheads.

      Key Steps in Accounting for Self Constructed Assets

      Accounting for these assets involves the understanding of a few key steps.

      1. Allocation of Costs: Allocate all direct and indirect costs incurred during production to the appropriate asset account.
      2. Period of Capitalisation: Determine the period over which costs should be capitalised, generally from the decision to make the asset until it is substantially complete and ready for use.
      3. Stopping Capitalisation: Stop capitalising costs when the asset is ready for use, even if it is not yet in use.

      In some instances, especially if the production period is lengthy, an interest cost associated with funds tied up in the construction should also be capitalised as a part of the cost of the asset. This practice is referred to as capitalisation of interest.

      Role of GAAP in Accounting for Self Constructed Assets

      In line with the Generally Accepted Accounting Principles (GAAP), the costs associated with self constructed assets must be classified as capital expenditures rather than operational expenses. Capitalising these costs helps to spread them out over the useful life of the asset, thereby enhancing the accuracy of financial statement over time.

      This principle is dictated by GAAP under "Property, Plant and Equipment" (US GAAP's ASC 360 or IFRS's IAS 16). Here, direct and indirect costs that are clearly attributable to the acquisition, construction or production of assets are required to be capitalised, if it's probable that the asset will generate economic benefit.

      GAAP serves as the comprehensive overall set of standards that guides businesses on how to maintain and prepare their financial statements. Adhering to GAAP allows for consistency and transparency in financial recording, especially essential when stakeholders need to gauge the financial health and history of a business.

      It is therefore important that firms adhere to the GAAP standards while accounting for their self constructed assets to promote comparability and transparency in their financial reporting.

      Capitalisation of Self Constructed Assets

      Capitalisation is an essential aspect of accounting for self constructed assets. It involves attributing the costs associated with the production of the asset, including certain interest costs, to the value of the asset. This process allows the firm to recover the expenditure over the service life of the asset by processing it as a depreciation expense.

      Interest Capitalization on a Self-Constructed Asset

      If you undertake a project that involves significant expenditure and spans over a lengthy period of time, it's not uncommon to borrow funds for the project. The interest that arises during the construction period enhances the cost of the asset. Neglecting to capitalise this interest as part of the production cost often leads to an understatement of the asset's cost and an overstatement of the net income in the period.

      Interest capitalisation is a method under which interest expenses incurred during the construction period of a self constructed asset are added to the cost of the asset rather than being charged as an expense for the period.

      Understanding the Concept of Interest Capitalization

      The process of interest capitalisation commences when three conditions are met:

      • The expenditures for the asset have been made.
      • The activities that are necessary to prepare the asset for its intended use are in progress.
      • Interest costs are being incurred.

      The capitalisation period ends when the asset is substantially complete and ready for use. It's important to note that the asset doesn't have to be in use for interest capitalisation to stop; it just needs to be ready for use.

      For instance, suppose your company has constructed a warehouse with loan funds. The construction started on 1st January, and by 31st March, the warehouse is ready for use, even if it's not used until 1st June. The interest capitalisation would stop at 31st March when the warehouse became ready for use.

      Application of Interest Capitalization on a Self-Constructed Asset

      Interest capitalisation applies to assets that are self constructed for a company's own use and assets intended for sale or lease provided the activities necessary to get them ready for sale or lease are in progress.

      Furthermore, the specific interest that is to be capitalised is determined by the lesser of the actual interest costs incurred during the capitalisation period or the potential interest that could have been avoided if the expenditure for the asset had not been made i.e., "avoidable interest".

      Here's how you calculate:

      \[ \text{Avoidable Interest} = \text{Weighted-average expenditure amount} \times \text{Interest rate} \]

      In the equation above, the weighted average expenditure amount is the sum of the expenditures for the asset weighted by the amount of time (fraction of a year or accounting period) that an expenditure is outstanding.

      Self Constructed Assets Capitalization Process

      The capitalisation process of self constructed assets involves recognising and recording costs associated with their construction and production in the financial statements correctly. It allows the company to spread the costs incurred on the asset's creation over the asset's useful life, rather than treating them as expenses in the period they were identified.

      How to Capitalise the Costs of Self Constructed Assets

      The capitalization process is a systematic step to ensuring that all direct and indirect costs related to the asset's production are duly accounted for:

      1. Identify all Direct Costs: Determine all the costs that are directly associated with the production of the asset. This includes raw materials and labour costs.
      2. Identify all Indirect Costs: Determine all the costs not directly associated with the production but are needed for the creation of the asset. This includes costs such as depreciation, factory overhead, etc. Only those indirect costs that increase during the construction period due to construction effort should be capitalised.
      3. Start Capitalisation: Capitalise these costs from the time you decide to create the asset and continue until the asset is substantially complete and ready for use.
      4. Include Interest Costs (if any): The capitalisation of interest is an important aspect to consider in cases where funds are borrowed to finance the construction of assets.
      5. Stop Capitalisation: It's imperative to stop capitalising costs when the asset is ready for use, even if it is not yet in use.

      Understanding these steps will provide a clear foundation for the capitalisation of self constructed assets, keeping your accounting books accurate and compliant with standard accounting principles.

      Self Constructed Assets According to International Standards

      When navigating through the world of self constructed assets, understanding the international accounting standards becomes of utmost importance. The Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS) are two critical frameworks that guide the recognition and valuation of such assets. As global standards, they define how self constructed assets should be calculated, reported and disclosed in financial reporting.

      Self Constructed Assets under GAAP

      In the U.S., GAAP is the standard framework of guidelines for financial accounting. It includes the standards, conventions, and rules accountants follow in recording and summarising transactions and in the preparation of financial statements. It's crucial to understand the GAAP-specific rules and approaches required to accurately account for self constructed assets.

      GAAP Guidelines for Self Constructed Assets

      According to the GAAP, self constructed assets should include all costs directly associated with the creation of assets such as material and labor costs, as well as a proportional share of indirect costs that are incurred in creating the asset.

      The GAAP recognizes costs such as administration and general overheads as a period expense and not part of the production cost. However, it does allow for the capitalisation of interest on borrowings for the construction, as a part of the asset cost. This is in accordance with the Interest Capitalization standard (Section 835-20 of the FASB Accounting Standards Codification). Accordingly, the interest capitalisation begins when the construction starts and ends when construction is substantially complete or production is suspended.

      Furthermore, under GAAP rules, the costs of assets manufactured for the purpose of being sold are considered inventory and not capitalised.

      Differences in Self Constructed Assets: GAAP vs. IFRS

      While both GAAP and IFRS provide standards for accounting for self constructed assets, a few key distinctions exist.

      Unlike the GAAP, the IFRS doesn't require companies to capitalise interest for self constructed assets. Furthermore, the IFRS requires the capitalisation of 'directly attributable costs', which includes a wider range of expenses such as direct labour costs, cost of site preparation, initial delivery, handling costs, installation costs, and professional fees.

      An additional difference lies in how each framework handles the classification of self constructed assets destined for sale. Unlike the GAAP that deems it inventory, the IFRS requires this to be capitalised as a non-current asset until the point of sale.

      Self Constructed Assets under IFRS

      A much broader standard than GAAP, the IFRS is used in many parts of the world, including the European Union, Australia, and India. The IFRS standards for self constructed assets diverge from GAAP in a few areas providing a different set of guidelines for the valuation of such assets.

      IFRS Rules for Self Constructed Assets

      As per IFRS (IAS 16 and IAS 23 to be precise), the cost of self constructed assets includes directly attributable costs, which incorporates all direct costs and any directly attributable costs necessary to bring the asset to working condition for its intended use. The standard allows companies to select the method of allocating fixed overheads to the cost of conversion, but the allocation should be based on the normal operating capacity.

      Moving on to interest capitalisation, IFRS also provides guidance on the capitalisation of borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset. Generally, IFRS requires more interests to be capitalised, compared to GAAP.

      Under IFRS, similar to GAAP, interest capitalisation commences when the entity incurs borrowing costs and ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete.

      Similarities in Self Constructed Assets: GAAP vs. IFRS

      Despite their differences, GAAP and IFRS share some common ground when it comes to self constructed assets. Both standards agree that costs directly associated with the production of the asset, such as materials and labour costs, should be capitalised.

      Similarly, both GAAP and IFRS permit the capitalisation of interest cost on borrowings attributed to the construction of the assets. Nevertheless, the amount and period of capitalised interest may differ between the two standards due to their different rules for determining capitalisation rates and period.

      Finally, under both frameworks, the capitalisation ceases when the asset is ready for its intended use, irrespective of whether it is put into operation or not. In other words, both standards tie the cessation of capitalisation to the physical completion of the asset, not its operational phase.

      Practical Application: Self Constructed Assets Example

      Putting theory into practice is an effective approach for a comprehensive understanding of self constructed assets. A practical example would pinpoint the specifics of the asset cost identification, allocation and capitalisation processes. It will enhance your insight into these assets' conceptual framework and assist in honing your managerial and financial decision-making skills.

      Understanding Self Constructed Assets with Real-Life Examples

      A retail company intending to expand its operations plans to construct a new warehouse. The construction of the warehouse is considered a project, and the warehouse itself is a self constructed asset. It will be used to store inventory to supply stores across a region, directly influencing the company’s sales generation.

      The self constructed warehouse incurs a series of associated costs such as direct materials (bricks, cement, steel), direct labour (construction workers’ wages), directly attributable overheads (equipment rental), and indirect costs (general site management).

      Additionally, let's say the company borrowed $1,000,000 at a yearly interest rate of 5% to fund the construction project. The construction period lasts for 2 years, during which the company incurs interest costs. In accordance with the interest capitalisation rules, these costs should be capitalised and added to the cost of the warehouse.

      Breakdown of a Self Constructed Assets Example

      • Cost of Direct Materials: The cost of raw materials including the bricks, cement, steel and others are categorised as direct materials costs.
      • Cost of Direct Labour: The wages paid to the construction workers are designated as direct.labor costs.
      • Directly Attributable Overheads: Costs such as equipment rental that are directly attributable to the construction of the warehouse are categorised as directly attributable overheads.
      • Cost of Indirect Costs: Costs like general site management that don't directly contribute to the construction but are necessary for the project are considered indirect costs.
      • Interest Costs: Interest costs are capitalised according to the rules for capitalisation of borrowing costs. Using the formula for calculating the avoidable interest cost: \[ \text{Avoidable Interest} = \text{Weighted-average expenditure amount} \times \text{Interest rate} \] The total cost of interest over the two-year construction period will be \( $1,000,000 \times 5\% \times 2 = $100,000 \).

      The sum of these costs will constitute the total cost of the warehouse recorded in the company accounts as a self constructed asset.

      Learning from a Self Constructed Assets Case Study

      Let's take a deeper dive into this case and understand its implications on the company's financial statements. On completion of the warehouse construction, the company will add the total cost calculated above to its balance sheet as a non-current asset under 'Property, Plant and Equipment'. Depreciation expense will be recorded every accounting period to evenly distribute the cost of this asset over its useful life, following the matching principle of accounting.

      This capitalisation of the warehouse as an asset instead of expensing its costs in the periods they were incurred, leads to higher profits in the financial periods during the construction. Consequently, it also results in higher assets, and potentially higher equity, depending on the financing of the warehouse's construction. These would not have been the case if the company simply expensed all the costs as and when incurred.

      From this case study, it's clear that understanding the handling of self constructed assets in accounting is not just about recording the correct figures in financial statements. It also influences the analysis and interpretation of these financial statements, affecting the perceived financial health and performance of the company.

      Self Constructed Assets - Key takeaways

      • The costs of resources like raw materials and labour consumed during the creation of Self Constructed Assets are technically not 'expenses' in the traditional sense but are to be capitalized as they increase the value of the asset under construction, and are expected to provide benefits beyond the current period.
      • Costs of a self constructed asset should be capitalized until the asset is substantially complete and ready for use. These costs include direct costs like material and labour costs, and those indirect costs that increase during the construction period due to the construction effort.
      • Accounting for Self Constructed Assets involves allocating all direct and indirect costs incurred during production, determining the period over which costs should be capitalized, and stopping capitalization when the asset is ready for use, even if it is not yet in use.
      • In some cases, an interest cost associated with funds tied up in the construction should also be capitalized as a part of the cost of the asset. This practice is referred to as interest capitalization.
      • GAAP dictates that costs associated with self constructed assets must be classified as capital expenditures rather than operational expenses, and should be capitalized if it's probable that the asset will generate economic benefit. Meanwhile, under IFRS, the cost of self constructed assets includes directly attributable costs necessary to bring the asset to working condition for its intended use, and it provides guidance on the capitalisation of borrowing costs that are directly attributable to the acquisition, construction or production of an asset.
      Self Constructed Assets Self Constructed Assets
      Learn with 30 Self Constructed Assets flashcards in the free StudySmarter app

      We have 14,000 flashcards about Dynamic Landscapes.

      Sign up with Email

      Already have an account? Log in

      Frequently Asked Questions about Self Constructed Assets
      What is the accounting treatment for self-constructed assets in a business?
      Self-constructed assets are capitalised in a business's accounts. Costs associated with their construction like direct materials, labour, overhead costs etc., are accounted for under the asset's value. Any profit earned during the construction phase is typically recognised as a liability, not revenue.
      How are self-constructed assets valued under the International Financial Reporting Standards (IFRS)?
      Self-constructed assets under the International Financial Reporting Standards (IFRS) are valued at their actual production cost. This includes direct materials and labour, and proportion of manufacturing overheads. The cost of self-constructed assets also includes any other costs directly attributable to bringing them into working condition.
      What is the effect of self-constructed assets on a company's balance sheet and overall financial health?
      Self-constructed assets, like machinery or software developed in-house, add to a company's fixed assets on its balance sheet, thereby increasing total assets. This enhances the company's overall financial health as it may strengthen the company's equity base and may boost its borrowing capacity.
      What costs are typically involved in the creation of self-constructed assets for a company?
      The costs typically involved in the creation of self-constructed assets for a company include direct materials, direct labour, other direct costs, and a proportionate share of production overheads. These may also include planning, designing, testing, and any necessary borrowing costs.
      What are the tax implications for a business with regard to self-constructed assets?
      The tax implications for self-constructed assets include capitalisation of interest during construction which can be deducted over the asset's useful life. Businesses may also be able to claim capital allowances for the depreciation of the asset. However, tax laws vary so advice should be sought.
      Save Article

      Test your knowledge with multiple choice flashcards

      What are Self Constructed Assets in the context of business studies and accounting?

      What is a major difference when valuing self-constructed assets under GAAP and IFRS standards?

      What is the expectation for companies regarding disclosure of self-constructed assets under GAAP and IFRS?

      Next

      Discover learning materials with the free StudySmarter app

      Sign up for free
      1
      About StudySmarter

      StudySmarter is a globally recognized educational technology company, offering a holistic learning platform designed for students of all ages and educational levels. Our platform provides learning support for a wide range of subjects, including STEM, Social Sciences, and Languages and also helps students to successfully master various tests and exams worldwide, such as GCSE, A Level, SAT, ACT, Abitur, and more. We offer an extensive library of learning materials, including interactive flashcards, comprehensive textbook solutions, and detailed explanations. The cutting-edge technology and tools we provide help students create their own learning materials. StudySmarter’s content is not only expert-verified but also regularly updated to ensure accuracy and relevance.

      Learn more
      StudySmarter Editorial Team

      Team Business Studies Teachers

      • 19 minutes reading time
      • Checked by StudySmarter Editorial Team
      Save Explanation Save Explanation

      Study anywhere. Anytime.Across all devices.

      Sign-up for free

      Sign up to highlight and take notes. It’s 100% free.

      Join over 22 million students in learning with our StudySmarter App

      The first learning app that truly has everything you need to ace your exams in one place

      • Flashcards & Quizzes
      • AI Study Assistant
      • Study Planner
      • Mock-Exams
      • Smart Note-Taking
      Join over 22 million students in learning with our StudySmarter App
      Sign up with Email