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Defining and Determining the Cost of an Asset

Definition of Cost

The cost of an asset encompasses all expenses necessary to bring the asset to its intended use. This means it's not just the purchase price but includes all related expenditures until the asset is ready for operation.

Items Included in the Cost

The following items are typically included in the cost of an asset:

  • Invoice Price: The price paid to the supplier as per the invoice.
  • Taxes: Taxes like Goods and Services Tax (GST) or Value Added Tax (VAT) are included.
  • Transportation Costs: Expenses incurred to transport the asset to its location.
  • Erection and Commissioning Costs: Costs associated with installing, assembling, and testing the asset to ensure it's operational. This includes trial runs.

General Principle: The cost is the sum of all expenses incurred until the asset is ready for its intended use.

Examples

  • Land with a Building: If a purchased property includes an existing building that needs demolition before new construction, the demolition cost is part of the new building's cost.
  • Imported Machinery: When commissioning imported machinery requires foreign technicians, their travel, accommodation, and related expenses are included in the machine's cost.

Note: Some companies might choose to expense certain items (like technician travel) rather than capitalize them, but the general principle is to include all necessary costs.

Self-Constructed Assets

For assets constructed by the company itself (e.g., buildings, machinery in process industries), the cost includes:

  • Materials: Cost of raw materials used in construction.
  • Labor: Wages and salaries of workers involved in construction.
  • Direct Expenses: Other expenses directly related to the project.
  • Allocated Overhead: A portion of the company's overhead costs allocated to the project.
  • Interest on Construction Loan: Interest paid or payable on loans taken specifically for the asset's construction until the asset is ready for use is capitalized (added to the asset's cost). Interest paid after the asset is ready for use is expensed.

Non-Cash Acquisitions (Issuance of Shares or Bonds)

When an asset is acquired by issuing equity shares or bonds, determining the asset's value requires a different approach:

  1. Fair Value of Shares/Bonds: The primary method is to determine the fair value of the issued shares or bonds. If this can be reliably measured, the asset's value is equal to the fair value of the shares/bonds.

  2. Fair Value of the Asset (If Shares/Bonds Fair Value is Undeterminable): If the fair value of the shares or bonds cannot be reliably determined (e.g., for an unlisted company), then the fair value of the asset itself is used to determine its cost.

Example:

A company purchases high-tech equipment. The seller's quoted price is ₹60 crore. The seller agrees to accept 1 crore shares of the company as payment.

  • Scenario 1 (Listed Company): If the market price of the company's shares is ₹58 per share, the fair value of the shares is ₹58 crore (1 crore shares * ₹58/share). Therefore, the value of the equipment is considered to be ₹58 crore, not ₹60 crore.
  • Scenario 2 (Unlisted Company): If the company is unlisted and the market value of its shares is not readily available, then the quoted price of ₹60 crore is used as the value of the equipment, assuming there's no other evidence suggesting a different fair value.
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