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Chapter 10: Q1CRC (page 551)

Your client is in the planning phase for a major plant expansion, which will involve the construction of a new warehouse. The assistant controller does not believe that interest cost can be included in the cost of the warehouse, because it is a financing expense. Others on the planning team believe that some interest cost can be included in the cost of the warehouse, but no one could identify the specific authoritative guidance for this issue. Your supervisor asks you to research this issue.

Instructions

If your school has a subscription to the FASB Codification, go to http://aaahq.org/asclogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses.

  1. Is it permissible to capitalize interest into the cost of assets? Provide authoritative support for your answer.
  2. What are the objectives for capitalizing interest?
  3. Discuss which assets qualify for interest capitalization.
  4. Is there a limit to the amount of interest that may be capitalized in a period?
  5. If interest capitalization is allowed, what disclosures are required?

Short Answer

Expert verified
  1. Yes, it is permissible to capitalize the interest.
  2. The purpose of capitalizing interest is to calculate the acquisition cost.
  3. Assets that are constructed, assets intended for sale or lease, and investments.
  4. The total capitalized amount shall not exceed the total amount of interest cost.
  5. Expenses should be disclosed when interest costs are incurred.

Step by step solution

01

Meaning of Capitalization of Interest.

As with other interests, capitalized interest accumulates on an asset or loan, but it is not immediately recognized as an expense on the income statement.The accrued interest is instead deducted from the asset's value on the income statement, which includes the interest in its total value on the balance sheet.

02

(a) Explaining the possibility of capitalizing interest on the cost of assets.

According to FASB ASC 835-20-05, interest must be capitalized into the cost of assets that fulfill the conditions outlined in step 4 below.

03

(b) Explaining the objectives of capitalizing interest.

According to FASB ASC 835-20-10-1,

The capitalizing interest aims to measure acquisition cost that more accurately reflects an entity's entire investment in the asset and to charge a fee associated with purchasing a resource that will benefit future periods against the revenues of those periods.

04

(c) Explaining the assets that qualify for interest capitalization.

According to FASB ASC 835-20-15-5

The following sorts of assets (qualifying assets) must have the interest capitalized:

  1. An entity's construction and productions and assets have been constructed or produced for it by others for which contributions have been made.
  2. Assets are built or manufactured as distinct projects (for example, ships or real estate developments) and designed for sale or leasing.
  3. A company should account for investments (equity, loans, and advances) using the equity method when it is engaged in activities required to commence its anticipated primary operations if the company is using money to acquire qualifying assets.
05

(d) Explaining whether there is a limit to the amount of interest that may be capitalized in a period.

According to FASB ASC 835-20-30-6,

The entire amount of interest expense capitalized in a given accounting period must not exceed the company's total interest expense incurred. That limitation will be applied to the total interest expense incurred by the parent business and consolidated subsidiaries on a consolidated basis in consolidated financial statements. The rule shall be used by reference to the total amount of interest cost (including interest on intra-entity borrowings) incurred by the separate entity in any separately issued financial statements of a parent entity or consolidated subsidiaries and the financial reports (whether separately issued or not) of unconsolidated subsidiaries and other investees accounted for by the equity method.

06

(e) Explaining the disclosure.

According to FASB ASC 835-20-50-1,

In its financial statements or associated notes, an organization must report the following information about interest costs:

  1. For accounting periods in which interest is not capitalized, the interest expense is incurred during that period.
  2. The overall amount of interest charges incurred over a financial year and the capitalized amount.

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Most popular questions from this chapter

Hanson Company is constructing a building. Construction began on February 1 and was completed on December 31. Expenditures were \(1,800,000 on March 1, \)1,200,000 on June 1, and $3,000,000 on December 31. Compute Hanson鈥檚 weighted-average accumulated expenditures for interest capitalization purposes.

Question: What interest rates should be used in determining the amount of interest to be capitalized? How should the amount of interest to be capitalized be determined?

Cheng Company traded a used truck for a new truck. The used truck cost \(30,000 and has accumulated depreciation of \)27,000. The new truck is worth \(37,000. Cheng also made a cash payment of \)36,000. Prepare Cheng鈥檚 entry to record the exchange. (The exchange lacks commercial substance.)

(Acquisition, Improvements, and Sale of Realty) Tonkawa Company purchased land for use as its corporate headquarters. A small factory that was on the land when it was purchased was torn down before construction of the office building began. Furthermore, a substantial amount of rock blasting and removal had to be done to the site before construction of the building foundation began. Because the office building was set back on the land far from the public road, Tonkawa Company had the contractor construct a paved road that led from the public road to the parking lot of the office building.

Three years after the office building was occupied, Tonkawa Company added four stories to the office building. The four stories had an estimated useful life of 5 years more than the remaining estimated useful life of the original office building.

Ten years later, the land and building were sold at an amount more than their net book value, and Tonkawa Company had a new office building constructed in another state for use as its new corporate headquarters.

Instructions

  1. Which of the expenditures above should be capitalized? How should each be depreciated or amortized? Discuss the rationale for your answers.
  2. How would the sale of the land and building be accounted for? Include in your answer an explanation of how to determine the net book value at the date of sale. Discuss the rationale for your answer.

(Acquisition Costs of Realty) The following expenditures and receipts are related to land, land improvements,

and buildings acquired for use in a business enterprise. The receipts are enclosed in parentheses.

(a) Money borrowed to pay building contractor (signed a note) \((275,000)

(b) Payment for construction from note proceeds 275,000

(c) Cost of land fill and clearing 8,000

(d) Delinquent real estate taxes on property assumed by purchaser 7,000

(e) Premium on 6-month insurance policy during construction 6,000

(f) Refund of 1-month insurance premium because construction completed early (1,000)

(g) Architect鈥檚 fee on building 22,000

(h) Cost of real estate purchased as a plant site (land \)200,000 and building $50,000) 250,000

(i) Commission fee paid to real estate agency 9,000

(j) Installation of fences around property 4,000

(k) Cost of razing and removing building 11,000

(l) Proceeds from salvage of demolished building (5,000)

(m) Interest paid during construction on money borrowed for construction 13,000

(n) Cost of parking lots and driveways 19,000

(o) Cost of trees and shrubbery planted (permanent in nature) 14,000

(p) Excavation costs for new building 3,000

Instructions

Identify each item by letter and list the items in columnar form, using the headings shown below. All receipt amounts should be

reported in parentheses. For any amounts entered in the Other Accounts column, also indicate the account title.

Item Land Land Improvements Buildings Other Accounts
See all solutions

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