A self-constructed asset is one that a business elects to construct under its own management. A common example of a self-constructed asset is when a company chooses to build an entire facility. In most cases, fixed assets are not self-constructed; instead, they are purchased from third parties, with little additional effort required to install them on-site. When an asset is constructed by a general contractor and then title passes to the buyer, this is not considered a self-constructed asset.
When an asset is self-constructed, it can be quite difficult to formulate the cost of the asset, since there are many types of costs to consider. Use the following steps to accumulate the necessary information:
- Create a separate job in the accounting system for the asset that is to be self-constructed.
- Assign the unique job number to all expenditures needed to construct the asset. The job number and related cost is entered into the accounting system by the accounts payable staff, so that these costs are assigned to the asset.
- Have employees assign hours worked to the unique job number. The job number and related hours worked are entered into the accounting system by the payroll staff. The hours worked are then multiplied by the hourly pay rate of each employee and then assigned to the asset.
- Allocate overhead costs to the asset. These costs will be closely reviewed by the company's auditors, so be sure to develop a standard methodology for assigning costs and follow it with no exceptions. To avoid charges of excessive overhead allocation, be cautious in assigning costs to overhead that might otherwise be construed as period costs.
- Assign interest expense to the asset. The amount of interest applied is limited to the time period covered by construction, and calculated as the interest rate multiplied by the average accumulated expenditures in each accounting period. The amount capitalized is limited to the total amount of actual interest expense incurred by the company during the construction period.
- Terminate cost accumulation. Stop accumulating costs for the asset as soon as it is ready for the purpose for which it was intended.
- Depreciate the asset. Commence depreciating the asset over its useful life. It may be possible to use an accelerated depreciation method to defer the recognition of taxable income.
If a self-constructed asset is to be sold at a later date, do not recognize the anticipated profit as part of the construction accounting. Instead, any profit is only recognized when the asset is sold to a third party.