What is acquisition cost and how is it calculated? Let’s have a look at that, and what it eventually depicts.
The concept of acquisition cost applies to the acquisition of fixed assets such as land, building, machinery, equipment, etc., that an organization uses for commercial or business purposes. This accounting is done to ascertain the actual financial expense of an asset, and includes many other costs besides the purchase price. Acquisition cost is also known as book value or asset book value. This asset book value appears in the balance sheet under fixed assets. The acquisition cost of an asset, especially in case of plant machinery and equipment, includes (besides purchase price) all the costs incurred to get the asset in working and running condition in order to start production.
Acquisition Cost Principles
The following points encapsulate the underlying concept of acquisition cost for the purpose of accounting for fixed assets of a manufacturing company.
- Acquisition cost of an asset includes all additional costs incurred for getting title over and legal ownership of such asset. Such additional expenses may include various fees, commission, etc.
- Acquisition cost, especially of machinery and equipment, is also inclusive of additional expenses that are incurred in getting such fixed asset to the desired location, say, the plant. Examples of such additional carrying cost includes cost of transportation, octroi, toll, storage cost (if the asset is to be transported across stations and warehousing is required on the way), etc.
- Once delivered at the desired location, machinery and equipment may require to be tested and installed before they are yoked for full-fledged production. These processes may call for equipment testing and installation costs.
- Some fictitious costs/expenses are deducted from the purchase price to arrive at the acquisition cost. These include depreciation, amortization, impairment cost, discounts received, etc. This is in compliance with the accounting convention of conservatism, where the highest cost figure and the lowest revenue figure are considered to arrive at a worst-case-scenario difference (profit or loss) figure.
- The figure excludes tax amounts paid for acquiring the asset.
- It is calculated after adjustments are made for all kinds of discounts, transfer costs, closing costs and other adjustment items.
- Such other adjustments may include cost of financing the purchase of the asset.
- As opposed to acquisition cost of an asset, customer acquisition cost is a different concept pertaining to sales and marketing where all expenses incurred in converting a prospect into a customer are included. Examples of customer acquisition cost may include telephone bills, conveyance charges, expenses incurred for meeting customers, cost of samples, etc.
Acquisition Cost Formula
In its accounting sense, the acquisition cost of an asset can be calculated using the following formula:-
Acquisition Cost = (Purchase price + Additional direct expenses pertaining to acquisition) – (Depreciation+Amortization+Taxes+Impairment costs)
If you’re wondering why it is always acquisition cost, less depreciation, the reason is that, although the depreciation figure is ultimately deducted from the value of the assets, depreciation is a numerical depiction of decline in the value of the asset over a given period of time. It is also a way of allocating the cost of the asset over the time period for which it is put to use. Therefore, in no way is it a charge that is incurred during and for the sole reason of acquiring an asset. Hence, keeping depreciation away from the acquisition cost maintains a clarity as to the exact amount attributable to acquisition.
Judging by all of the above, acquisition cost basically comprises two chief components―monetary consideration paid for the purchase (purchase price) and additional direct costs for getting ownership of the purchased asset and getting it in working condition. Unless other factors like discounts, depreciation, etc., are not already added to the purchase price, adding the two main components (purchase price and direct acquisition overheads) will give you the acquisition cot of the asset.