Financial Statement Structure and Composition
Q: But isn't the action of buying the raw materials an expense, and the raw materials themselves become the asset?
A: The action is either a cash or an accrual action. That is, the buyer either pays cash for the materials or agrees to pay cash later. If the buyer does put the materials into immediate use in a category defined as an expense category, then the buyer will classify the materials as an asset he or she purchased.
The use of the materials is critical to properly accounting for it. For example, a company may buy a delivery van and use it immediately. But, given generally accepted accounting principles, the company must record the purchase as a fixed asset on its balance sheet and not as an expense.
The purchase of materials is much the same. The materials are recorded as assets until they are used up in the production process and sold as part of a product. Only then do they become an expense, applying the matching principle which we'll discuss in a subsequent session.
Poll Question 3 states, “If a manufacturing company buys $100,000 of raw materials for subsequent processing the $100,000 purchase represents:”
- An expense.
- An asset.
- A liability.
The correct response is “An asset.” The reason it is an asset is that the manufacturing company bought the raw materials for subsequent processing. It hasn’t processed them and sold them. They are in inventory, which is used to produce revenue. Inventory only becomes an expense when it is part of an asset that has been sold.
Q: Can prelim site costs be considered intangible?
A: Preliminary Site Costs reflect work in process, in effect, much like work in process for a company manufacturing pumps or producing footwear. The cost of the goods at any point in the production process is an asset for the company.
Preliminary Site Costs are essentially long-term work-in-process inventory. This asset represents expenses incurred to prepare a site for development, such as fees paid to survey teams and engineers. Before any cash can be realized from these preliminary site costs, they must be converted into a marketable product. In other words, Fresno Properties must complete the development of the site.
Conceivably, an asset could be a work in process and an intangible asset at the same time, although usually site costs are considered tangible assets. The classification as tangible or intangible reflects the accountant's decision. On the balance sheet of Fresno Properties, Preliminary Site Costs are classified as a tangible asset. The only intangible asset is Loan Fees – Loan Fees at historical cost of $63,063, less accumulated amortization of $46,283, equals Net Loan Fees of $16,780. No amortization is netted against Preliminary Site costs.
Course overview: Financial Statement Structure and Composition