Recognition of Expenses
Response to the following problem:
Kwik-Bild Corporation sells and erects shell houses. These are frame structures that are completely finished on the outside but are unfinished on the inside except for flooring, partition studding, and ceiling joists. Shell houses are sold chiefly to customers who are handy with tools and who have time to do the interior wiring, plumbing, wall completion and finishing, and other work necessary to make the shell houses livable dwellings.
Kwik-Bild buys shell houses from a manufacturer in unassembled packages consisting of all lumber, roofing, doors, windows, and similar materials necessary to complete a shell house. Upon commencing operations in a new area, Kwik-Bild buys or leases land as a site for its local warehouse, field office, and display houses. Sample display houses are erected at a total cost of from $10,000 to $30,000, including the cost of the unassembled packages. The chief element of cost of the display houses is the unassembled packages, since erection is a short, low-cost operation. Old sample models are torn down or altered into new models every three to seven years. Sample display houses have little salvage value because dismantling and moving costs amount to nearly as much as the cost of an unassembled package.
Required:
1. A choice must be made between (a) expensing the costs of sample display houses in the period in which the expenditure is made, and (b) spreading the costs over more than one period. Discuss the advantages of each method.
2. Is it preferable to amortize the cost of display houses on the basis of (a) the passage of time, or (b) the number of shell houses sold? Explain.