Describe whether you agree that capitalization of the tooling supplies is the preferable method of accounting for Auto Parts, Inc.

Question

What will be an ideal response?

Answer 1

The client’s change in policy is appropriate. Auto Parts, Inc. likely purchases tooling supplies in large
quantities in order to take advantage of supplier discounts and in the current year they increased
their purchases in anticipation of a price increase. It appears that the items purchased can remain in
inventory for weeks or months creating a future economic benefit. The preferred accounting method
for tooling supplies is to capitalize them on-hand tooling supply in other assets and then expense
supplies as they are placed in service. The decision regarding capitalization or expense is based on
the concepts of future economic value, the matching principle, classification, and disclosure. Accrual
accounting requires expenses to be matched to the revenues they help produce in a given period.
Technically, to expense tooling costs at the time of purchase violates the matching principle.
While the “technically proper” treatment of accounting for tooling supplies was also to capitalize
in the prior and earlier years, accounting and auditing standards allow for the pervasive constraints
of cost-benefit and materiality. Prior to 2018, the amount of tooling supplies on-hand at year-end
was immaterial. As such, the costs associated with capitalizing, tracking, counting, etc. exceeded the
benefits, at least in the client’s eyes.
The cost-benefit concept can lead to interesting discussions regarding whether, in situations
like Auto Parts, it really would have been all that difficult or costly for the client to count the tooling
supplies at year-end. The problem with not accounting appropriately for tooling supplies, as in this
example, is that if and when it becomes material the client and the auditor have to exert time and
energy to determine the proper way to account for the change. In other words, not following GAAP in
this situation may ultimately been more costly than following GAAP all along.