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Chapter 10: Q5Q (page 502)
Question: When should debt security be classified as held-to-maturity?
Answer:
When an investor can hold it till the maturity of the security, it is classified as held-to-maturity.
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Question: Indicate where the following items would be shown on a balance sheet. (a) A lien that was attached to the land when purchased. (b) Landscaping costs. (c) Attorney鈥檚 fees and recording fees related to purchasing land. (d) Variable overhead related to construction of machinery. (e) A parking lot servicing employees in the building. (f) Cost of temporary building for workers during construction of building. (g) Interest expense on bonds payable incurred during construction of a building. (h) Assessments for sidewalks that are maintained by the city. (i) The cost of demolishing an old building that was on the land when purchased.
(Capitalization of Interest) The following three situations involve the capitalization of interest
Situation I: On January 1, 2017, Oksana Baiul, Inc. signed a fixed-price contract to have Builder Associates construct a major plant facility at a cost of \(4,000,000. It was estimated that it would take 3 years to complete the project. Also on January 1, 2017, to finance the construction cost, Oksana Baiul borrowed \)4,000,000 payable in 10 annual installments of \(400,000, plus interest at the rate of 10%. During 2017, Oksana Baiul made deposit and progress payments totaling \)1,500,000 under the contract; the weighted average amount of accumulated expenditures was \(800,000 for the year. The excess borrowed funds were invested in short-term securities, from which Oksana Baiul realized investment income of \)250,000.
Instructions
What amount should Oksana Baiul report as capitalized interest at December 31, 2017?
Situation II: During 2017, Midori Ito Corporation constructed and manufactured certain assets and incurred the following interest costs in connection with those activities.
Interest Costs Incurred | |
Warehouse constructed for Ito鈥檚 own use | \(30,000 |
Special-order machine for sale to unrelated customer, produced according to customer鈥檚 specifications | 9,000 |
Inventories routinely manufactured, produced on a repetitive basis | 8,000 |
All of these assets required an extended period of time for completion.
Instructions
Assuming the effect of interest capitalization is material, what is the total amount of interest costs to be capitalized?
Situation III: Peggy Fleming, Inc. has a fiscal year ending April 30. On May 1, 2017, Peggy Fleming borrowed \)10,000,000 at 11% to finance construction of its own building. Repayments of the loan are to commence the month following completion of the building. During the year ended April 30, 2018, expenditures for the partially completed structure totaled \(7,000,000. These expenditures were incurred evenly throughout the year. Interest earned on the unexpended portion of the loan amounted to \)650,000 for the year.
Instructions
How much should be shown as capitalized interest on Peggy Fleming鈥檚 financial statements on April 30, 2018?
New machinery, which replaced a number of employees, was installed and put in operation in the last month of the fiscal year. The employees had been dismissed after payment of an extra month鈥檚 wages, and this amount was added to the cost of the machinery. Discuss the propriety of the charge. If it was improper, describe the proper treatment.
(Capitalization of Interest) Vania Magazine Company started construction of a warehouse building for its own use at an estimated cost of \(5,000,000 on January 1, 2016, and completed the building on December 31, 2016. During the construction period, Vania has the following debt obligations outstanding.
Construction loan鈥�12% interest, payable semiannually, issued December 31, 2015 | \)2,000,000 |
Short-term loan鈥�10% interest, payable monthly, and principal payable at maturity, on May 30, 2017 | 1,400,000 |
Long-term loan鈥�11% interest, payable on January 1 of each year; principal payable on January 1, 2019 | 1,000,000 |
Total cost amounted to \(5,200,000, and the weighted average of accumulated expenditures was \)3,500,000.
Jane Esplanade, the president of the company, has been shown the costs associated with this construction project and capitalized on the balance sheet. She is bothered by the 鈥渁voidable interest鈥� included in the cost. She argues that, first, all the interest is unavoidable鈥攏o one lends money without expecting to be compensated for it. Second, why can鈥檛 the company use all the interest on all the loans when computing this avoidable interest? Finally, why can鈥檛 her company capitalize all the annual interest that accrued over the period of construction?
Instructions
(Round the weighted-average interest rate to two decimal places.)
You are the manager of accounting for the company. In a memo, explain what avoidable interest is, how you computed it (being especially careful to explain why you used the interest rates that you did), and why the company cannot capitalize all its interest for the year. Attach a schedule supporting any computations that you use.
(Capitalization of Interest) On July 31, 2017, Amsterdam Company engaged Minsk Tooling Company to construct a special-purpose piece of factory machinery. Construction was begun immediately and was completed on November 1, 2017. To help finance construction, on July 31 Amsterdam issued a \(300,000, 3-year, 12% note payable at Netherlands National Bank, on which interest is payable each July 31. \)200,000 of the proceeds of the note was paid to Minsk on July 31. The remainder of the proceeds was temporarily invested in short-term marketable securities (trading securities) at 10% until November 1. On November 1, Amsterdam made a final \(100,000 payment to Minsk. Other than the note to Netherlands, Amsterdam鈥檚 only outstanding liability at December 31, 2017, is a \)30,000, 8%, 6-year note payable, dated January 1, 2014, on which interest is payable each December 31.
Instructions
(a) Calculate the interest revenue, weighted-average accumulated expenditures, avoidable interest, and total interest cost to be capitalized during 2017. (Round all computations to the nearest dollar.)
(b) Prepare the journal entries needed on the books of Amsterdam Company at each of the following dates.
(1) July 31, 2017.
(2) November 1, 2017.
(3) December 31, 2017.
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