Question

P10.6 On June 28, 2020, in relocating to a new town, Kerr Corp. purchased a property consisting of two hectares of land and an unused building for $225,000 plus property taxes in arrears of $4,500. The company paid a real estate broker a fee of $12,000 for finding the property and legal fees on the purchase transaction of $6,000. The closing statement indicated that the assessed values for property tax purposes were $175,000 for the land and $35,000 for the building. Shortly after acquisition, the building was demolished at a cost of $24,000.

Kerr Corp. then entered into a $1.3-million fixed-price contract with Maliseet Builders Inc. on August 1, 2020, for the construction of an office building on this site. The building was completed and occupied on April 29, 2021, as was a separate maintenance building that was constructed by Kerr's employees. Additional costs related to the property included:

Plans, specifications, and blueprints		$25,000
Architects' fees for design and supervision		82,000
Landscaping		42,000
Extras on contract for upgrading of windows		46,000
External signage on the property		23,000
Advertisements in newspaper and on television announcing opening of the building		10,600
Gala opening party for customers, suppliers, and friends of Kerr		18,800
Costs of internal direct labour and materials for maintenance building		67,000
Allocated variable plant overhead based on direct labour hours worked on maintenance building		10,000
Allocated cost of executive time spent on project		54,000
Interest costs on debt incurred to pay contractor's progress billings up to building completion		63,000
Interest costs on short-term loan to finance maintenance building costs		3,200

As an incentive for Kerr to locate and build in the town, the municipality agreed not to charge its normal building permit fees of $36,000. This amount was included in the $1.3-million contract fee. Kerr uses the cost reduction method for any government grants, such as the waiving of these permit fees. The contract amount of $1.3 million was reduced by this grant. The building and the maintenance building are estimated to have a 40-year life from their dates of completion and will be depreciated using the straight-line method with no residual value.

Kerr is a private company with an April 30 year end, and the company accountant is currently analyzing the new Buildings account that was set up to capture all the expenditures and credits explained above that relate to the property.

Instructions

a. Prepare a schedule that identifies the costs that would be capitalized and included in the new Buildings account on the April 30, 2021 statement of financial position, assuming the accountant wants to comply with ASPE but tends to be very conservative in nature; in other words, she does not want to overstate income or assets. Briefly justify your calculations. How would your answer change if Kerr were to comply with IFRS?

b. Prepare a schedule that identifies the costs that would be capitalized and included in the new Buildings account on the April 30, 2021 statement of financial position, assuming the accountant wants to comply with ASPE, but is aware that Kerr needs to report increased income to support a requested increase in its bank loan next month. Briefly justify your calculations.

c. Comment on the difference in results for parts (a) and (b). Calculate the total expenses related to the building under both scenarios. What else should be considered in determining the amount to be capitalized?

Answer 1

a)
Kerr Co
Cost of Building
Conservative approach
Fixed price contract	$ 1,300,000.00
Plans, specifications and blueprints	$      25,000.00
Architect’s fees	$      82,000.00
Upgrading of windows	$      46,000.00
Internal direct labour and materials	$      67,000.00
Overhead based on direct labour hours	$      10,000.00
Less: Municipal government grant	$    (36,000.00)
Cost of building	$ 1,494,000.00
This is different from the IFRS standards, where borrowing costs are more widely defined as interest and other costs that an entity incurs in connection with the borrowing of funds. ASPE limits   capitalization to  interest   costs,   allows a choice between capitalization and expensing and   IFRS   requires capitalization  of  borrowing  costs  of  qualifying  assets.
b)
Kerr Co
Cost of Building
Increased Income approach
Fixed price contract	$ 1,300,000.00
Plans, specifications and blueprints	$      25,000.00
Architect’s fees	$      82,000.00
Upgrading of windows	$      46,000.00
Internal direct labour and materials	$      67,000.00
Overhead based on direct labour hours	$      10,000.00
Allocated cost of executive time	$      54,000.00
Interest cost on building construction	$      63,000.00
Interest cost on maintenance building construction	$        3,200.00
Less: Municipal government grant	$    (36,000.00)
Cost of building	$ 1,614,200.00
c)
30-Apr-21	Conservative approach	Increased Income approach
Allocated cost of executive time	$      54,000.00
Interest cost on building construction	$      63,000.00
Interest cost on maintenance building construction	$        3,200.00
Other expenses	$    120,200.00	0
Total expenses related to building	$    120,200.00	0
For subsequent years	Conservative approach	Increased Income approach
Depreciation expense ($1,494,000 / 40 years ; $1,614,200 / 40 years)	$      37,350.00	$ 40,355.00
Total expenses related to building	$      37,350.00	$ 40,355.00
In 2021 the conservative approach results in lower income and lower assets because expenditures such as the allocation of the executive’s cost and the interest  costs  on  self-construction of  the  building  and  maintenance  building  are  expensed.    In subsequent years however, higher income will result because of a lower depreciation expense.
The  accountant may also want to be consistent with U.S. GAAP  and  IFRS  where  capitalization  of  interest  is  required
The accountant should also consider the impact of capitalizing fixed overhead costs on the cost of products manufactured in the same year as the construction of the building. If assigning fixed overhead to the construction of the building results in lower than normal product costs due to lower production during construction, then a reasonable allocation of fixed costs may not be achieved
The company should  consider comparability  andc onsistency, as  well as  the need  for  financial  information  to  be faithfully  representative, objective,and neutral.