Component accounting is a fairly new term in the world of accounting, but it is quickly gaining popularity due to the many benefits it offers businesses.
So what is component accounting, and how does it work?
In this blog post, we will answer these questions and more!
What is Component Accounting?
Component Accounting is the process of assigning capital costs to a company asset so that its value improves. The new, higher value is then used to calculate depreciation and net book value.
It aims to provide more detail and insight into the true costs associated with producing products or services by breaking them down into their component parts. This allows businesses to better understand how each component impacts overall profitability as well as identify areas where money can be saved.
Useful life for significant components of tangible assets should be determined separately in order to fulfil the requirements under ‘Component Accounting.’ Companies therefore need to identify and depreciate significant components with different useful lives separately.
Say for example the life of an aircraft. Aircraft engines and fuselages have different useful lives. Both can be depreciated separately, but must follow the same rules for depreciation.
How Does Component Accounting Work?
Component accounting works in a few steps:
1. Breaking into Components
First, the capital costs associated with an asset acquisition are broken down into its component parts. These components can include labour, materials, overhead, and any other cost associated with creating or acquiring the asset.
2. Value Assigning
Next, each component is assigned a value based on its relevance to the asset. The resulting total is then used as the new, higher value of the asset when calculating depreciation and net book value.
Companies should also have a process in place to track when components need to be replaced or upgraded, as well as what costs are associated with those replacements or upgrades.
Component Accounting can be used for both tangible assets (such as machinery) and intangible assets (such as software). Businesses need to be mindful of the different rules that apply to each asset type.
Component Accounting is a useful tool for businesses looking to gain more insight into their costs and profitability, as it allows them to identify areas where money can be saved. Companies should consult with professionals before setting up a Component Accounting system to ensure that it meets their individual requirements.
Conclusion
Component accounting is a relatively new but popular form of accounting that allows businesses to better understand the true cost associated with their products or services.
It breaks down the capital costs associated with an asset acquisition into its component parts and assigns each part a value based on its relevance to the asset,
By following the guidelines of Component Accounting, businesses can gain a better understanding of how each component affects their overall profitability, allowing them to make smarter business decisions and improve their bottom line.
