Question

Early in its fiscal year ending December 31, 2018, San Antonio Outfitters finalized plans to expand operations. The first stage was completed on January 1 with the purchase of a tract of land on the outskirts of the city. The land and existing building were purchased for $880,000. San Antonio paid $240,000 and signed a noninterest bearing note requiring the company to pay the remaining $640,000 on January 1, 2020. An interest rate of 10% properly reflects the time value of money for this type of loan agreement. Title search, insurance, and other closing costs totaling $24,000 were paid at closing.

During January, the old building was demolished at a cost of $74,000, and an additional $54,000 was paid to clear and grade the land. Construction of a new building began on February 1 and was completed on December 1. Construction expenditures were as follows:

February 1 $ 1,800,000

April 30 2,400,000

July 1 800,000

November 1 1,200,000

San Antonio borrowed $4,500,000 at 9% on February 1 to help finance construction. This loan, plus interest, will be paid in 2019. The company also had the following debt outstanding throughout 2018:

$2,500,000, 10% long-term note payable

$5,500,000, 7% 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 $640,000. The fair values of the equipment and the furniture and fixtures were $555,000 and $185,000, respectively. In December, San Antonio paid a contractor $305,000 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 2018. 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 2018 income statement?

Answer 1

PART 1

Purchase price of land:

Cash paid = 240000

Value of note = 528928 (640000*0.82645 (PVIF10%,2yr))

Purchase price of land = 768928

Land

Purchase price = 768928

Closing costs = 24000

Removal of old building = 74000

Clearing and grading = 54000

Total cost of land = 920928

Land improvements

Parking lot and landscaping = 305000

Building

Construction expenditures:

February 1 - 1,800,000

April 30 - 2,400,000

July 1 - 800,000

November 1 - 1,200,000

Total expenditures – 6200000

Interest capitalized - 158333

Total cost of building = 6358333

Accumulated expenditures:

February 1 - 1,800,000 – (1800000*5/10) = 900000

April 30 - 2,400,000 – (2400000*3/10) = 720000

July 1 - 800,000 – (800000*2/10) = 160000

November 1 - 1,200,000 = (1200000*1/10) = 120000

Total accumulated expenditure = 1900000

Interest capitalized = 1900000*10%*10/12 = 158333

Equipment and furniture and fixture

	Fair value	% of total fair value	Initial valuation (640000)
Equipment	555000	75% (555000/740000)	480000	(640000*75%)
Furniture and fixtures	185000	25% (185000/740000)	160000	(640000*25%)
total	740000	100%	640000

Initial valuation:

Equipment = 480000

Furniture and fixtures = 160000

PART 2

Interest expense:

Note issued to purchase land and buildings (768928*10%*9/12) = 57670

Construction loan (4500000*9%*11/12) = 371250

Long –term note (2500000*10%) = 250000

Long-term bonds (5500000*7%) = 385000

Total = 1063920

Less: interest capitalized = 158333

Interest expense = 905587