Question

The Wong family incorporated Alberta Wholesale Limited (AWL) on January 1, 20X1 when the company issued common shares to several family members for cash. After obtaining mortgage financing, the company constructed a warehouse and began a food wholesale business.
The company has a small accounting staff that recorded transactions throughout the year. The company’s CEO knows that cash is correct because she has reviewed the bank reconciliation. However, she was unable to hire a professionally trained CFO and is concerned that the draft financial statements prepared by her staff (Exhibit I), which are prepared using IFRS, may have errors including the final calculation of income tax expense based on a 30% income tax rate.
The CEO has hired you to correct any accounting errors made by her staff by:
1. Providing a memo listing any adjusting entries that the company needs to make along with comments explaining why the company recorded items incorrectly and how and why the company should have recorded the transaction along with supporting calculations relating to adjustments. You should have at least one adjusting journal entry (you may need several entries for some issues) for each of the following issues. If an issue deals with more than one transaction, try to have an adjusting entry for each transaction within the issue.

Issue 1
On January 1, 20X1, the company received an operating line of credit from the bank for $6,000,000. The interest rate on this line was at 5% throughout 20X1. On that same day, AWL bought land costing $2,000,000 and on that day, construction on a warehouse commenced. The company paid the building contractor $4,000,000 on each of the following three dates for a total amount spent of $12,000,000: February 1, March 1 and April 1, 20X1. The contractor completed construction of the building by April 30, 20X1. AWL also received a $10,000,000 mortgage at 4% was received from the bank on February 28, 20X1 to pay for the warehouse. The mortgage required monthly payments of $101,246 on the last day of each month commencing March 31, 20X1. Interest on the line of credit is due on the first day of each month commencing February 1, 20X1. AWL paid no portion of the principal of the line of credit during 20X1 and there are no fixed terms of repayment on the line of credit although the bank can demand repayment at any time by giving 90 days notice and requires the company to maintain a current ratio greater than 3:1. Furthermore, the debt to equity ratio cannot exceed 1.5 so the company does not want to record any more liabilities if possible.

Issue 2
The company received a government grant of $1,000,000 cash on April 30 to make the warehouse more energy efficient. When received, we recorded it in grant revenue.

Answer 1

Borrowing cost attributable to the acquistion, construction or production of a qualifying asset are included in the cost of the asset.
Qualifying asset refers to the asset that necessarily takes a substantial period of time to get ready for its intended use or sale.
Here it is assumed that the warehouse constructed is a qualifying asset.
And IFRS pertaining to borrowing costs is applicable in the given case.

Jan 1, company received an operating line of credit upto $6000000, with interest rate being 5%.

Land purchased on Jan 1 for $2000000.
As the bank loan is provided for operating line of credit, it is assumed that the land purchsed is from the cash balance of the company.
However incase the land is purchased from the operating line of credit provided by the bank then interest on $2000000 will be charged on the bank credit for 5%.
Journal ( when bought from bank balance of company)
Land     Dr. 2000000
To Bank            2000000
(Being land purchased by the company.)

Journal ( when bought from credit provided by bank)
Land      Dr. 2000000
To Loan from Bank   2000000
(Being land purchased from credit provided by bank)

Journal on Feb 1
Warehouse a/c        Dr. 4000000
To Loan from Bank          4000000
(Being the amount paid to contractor for payment for construction of warehouse through credit from bank.)

Interest on $2000000 @ 5% for 1 month = $8333.33

Interest on loan a/c      Dr. 8333.33
To Interest payable a/c               8333.33
(Being the amount of interest due on loan of $2000000 for month of Jan)
Interest payable a/c      Dr.8333.33
To Bank a/c                               8333.33
(Being the amount of interest due paid)
Profit & Loss a/c          Dr.8333.33
   To Interest on loan                    8333.33
(Being the interest on loan transferred to profit & loss account.)

Note- As land is purchased on Jan 1, it is not a qualifying asset and hence the interest is charged as an revenue item of expenditure and is not capitalised with the value of land.

Feb 28 Bank a/c                        Dr 10000000
               To Mortgage from bank                    10000000
(Being mortgage received from bank for $10000000 @ 4%)

Journals on Mar 1

Warehouse a/c        Dr. 4000000
To Loan from Bank          4000000
(Being the amount paid to contractor for payment for construction of warehouse.)

Interest on $2000000 @ 5% for 1 Month ( Feb ) = $8333.33 (For purchase of land, treated as revenue expenditure.)
Interest on $4000000 @ 5% for 1 Month ( Feb ) = $16666.66 (For construction of warehouse, to be capitalised in the cost of warehouse.)

Interest on loan a/c      Dr. 25000
To Interest payable a/c               25000
(Being the amount of interest due on loan of $6000000 for month of Feb)
Interest payable a/c      Dr.25000
To Bank a/c                               25000
(Being the amount of interest due paid)
Profit & Loss a/c          Dr.8333.33
   To Interest on loan                    8333.33
(Being the interest on loan transferred to profit & loss account.)
Warehouse a/c            Dr. 16666.66
To Interest on loan                          16666.66
(Being the amount of interest paid capitalised with the value of warehouse.)

Mar 31

Interest on mortgage              Dr. 13333.33
To Interest payable                                 13333.33
(Being interest on mortgage due)
Interest payable                       Dr. 13333.33
Mortgage a/c                           Dr. 87912.67
To Bank                                                  101246
(Being monthly amount due on mortgage paid.)
Warehouse a/c                        Dr. 13333.33
To Interest on mortgage                           13333.33
(Being interest paid on mortgage for construction of warehouse capitalised.)

Interest paid on mortgage till the completion of warehouse is to be capitalised with the warehouse cost.

Journals on Apr 1

Warehouse a/c        Dr. 4000000
To Loan from Bank          4000000
(Being the amount paid to contractor for payment for construction of warehouse.)

Interest on $2000000 @ 5% for 1 Month ( Mar ) = $8333.33 (For purchase of land, treated as revenue expenditure.)
Interest on $4000000 @ 5% for 1 Month ( Mar ) = $16666.66 (For construction of warehouse, to be capitalised in the cost of warehouse.)

Interest on loan a/c      Dr. 25000
To Interest payable a/c               25000
(Being the amount of interest due on loan of $6000000 for month of Mar)
Interest payable a/c      Dr.25000
To Bank a/c                               25000
(Being the amount of interest due paid)
Profit & Loss a/c          Dr.8333.33
   To Interest on loan                    8333.33
(Being the interest on loan transferred to profit & loss account.)
Warehouse a/c            Dr. 16666.66
To Interest on loan                          16666.66
(Being the amount of interest paid capitalised with the value of warehouse.)

Apr 30

Interest on mortgage              Dr. 26666.66
To Interest payable                                 26666.66
(Being interest on mortgage due)
Interest payable                       Dr. 26666.66
Mortgage a/c                           Dr. 74579.34
To Bank                                                  101246
(Being monthly amount due on mortgage paid.)
Warehouse a/c                        Dr. 26666.66
To Interest on mortgage                           26666.66
(Being interest paid on mortgage for construction of warehouse capitalised.)



Grant received on Apr 30
Since the grant is received for making the warehouse more energy efficient, it is to be treated as grant received for specific warehouse asset. The treatment of grant received as grant revenue is not tenable under low.
There are 2 methods of doing it, either the amount can be shown as deferred income and can be amortized over the useful life of the asset or it can be deducted from the carrrying amount of the asset.

Case - 1

Bank a/c                  Dr 1000000
To Deferred Income                  1000000
(Being the grant amount received treated as deferred income to be amortized over the useful life of the asset.)

Case - 2

Bank a/c                 Dr 1000000
To Warehouse                           1000000
(Being the grant amount received reduced from the carrying amount of the warehouse.)