P 10-12 Acquisition costs; lump-sum acquisition; noninterest-bearing note; interest capitalization
P 10-12 Early in its fiscal year ending December 31, 2011, San Antonio Outfitters finalized plans to expand operations. The first stage was completed on March 28 with the purchase of a tract of land on the outskirts of the city. The land and existing building were purchased for $800,000. San Antonio paid $200,000 and signed a noninterest-bearing note requiring the company to pay the remaining $600,000 on March 28, 2013. An interest rate of 8% properly reflects the time value of money for this type of loan agreement. Title search, insurance, and other closing costs totaling $20,000 were paid at closing.
During April, the old building was demolished at a cost of $70,000, and an additional $50,000 was paid to clear and grade the land. Construction of a new building began on May 1 and was completed on October 29. Construction expenditures were as follows:
May 30 $1,200,000
July 30 1,500,000
September 1 900,000
October 1 1,800,000
San Antonio borrowed $3,000,000 at 8% on May 1 to help finance construction. This loan, plus interest, will be paid in 2012. The company also had the following debt outstanding throughout 2011:
$2,000,000, 9% long-term note payable
$4,000,000, 6% long-term bonds payable
In November, the company purchased 10 identical pieces of equipment and office furniture and fixtures for a lump-sum price of $600,000. The fair values of the equipment and the furniture and fixtures were $455,000 and $245,000, respectively. In December, San Antonio paid a contractor $285,000 for the construction of parking lots and for landscaping.
Required:
1. Determine the initial values of the various assets that San Antonio acquired or constructed during 2011. The company uses the specific interest method to determine the amount of interest capitalized on the building construction.
2. How much interest expense will San Antonio report in its 2011 income statement?
Problem 10-12
Requirement 1
Land
Purchase price (determined below) $714,404
Closing costs 20,000
Removal of old building 70,000
Clearing and grading 50,000
$854,404
Purchase price of land:
Cash paid $200,000
Value of note† 514,404
$714,404
† Present value of note payment:
PV = $600,000 (.85734) = $514,404
Present value of $1: n = 2, i = 8% (from Table 2)
Land improvements
Parking lot and landscaping $285,000
Building
Construction expenditures:
May 30 $1,200,000
July 30 1,500,000
September 1 900,000
October 1 1,800,000
Total expenditures 5,400,000
Interest capitalized (determined below) 94,000
Total cost of building $5,494,000
Average accumulated expenditures:
May 31, 2011 $1,200,000 x 5/6 = $ 1,000,000
July 30, 2011 1,500,000 x 3/6 = 750,000
September 1, 2011 900,000 x 2/6 = 300,000
October 1, 2011 1,800,000 x 1/6 = 300,000
$2,350,000
Interest capitalized:
$2,350,000 x 8% x 6/12 = $94,000
Equipment and furniture and fixtures
Initial
Percent of Total Valuation
Fair Value Fair Value % x $600,000
Equipment $455,000 65% $390,000
Furniture & fixtures 245,000 35% 210,000
Totals $700,000 100% $600,000
Initial valuation:
Equipment $390,000
Furniture & fixtures 210,000
Requirement 2
Interest expense:
Note issued to purchase land and building,
$514,404 x 8% x 9/12 = $ 30,864
Construction loan, $3,000,000 x 8% x 8/12 160,000
Long-term note, $2,000,000 x 9% 180,000
Long-term bonds, $4,000,000 x 6% 240,000
Total 610,864
Less: Interest capitalized (determined above) (94,000)
Interest expense $516,864
Assignment: Create a General Journal from the information above
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