Question

Question:

Large Mart has recently finished building a new factory for computers in Armidale. Large Mart was using its own staff and several items of its own machinery/equipment that were specifically acquired to undertake parts of the building works. The overall construction work took a total of 15 month, with Large Mart staff working on the project throughout this time.

The Large Mart Finance Department has calculated that during the 15 month construction time, the following expenditures occurred (please note that not all expenditures of the construction project are listed).

Total depreciation of the “Machinery/Equipment” account of $30,000. With $20,000 of this amount being for the depreciation of machinery/equipment that was specifically acquired for the project and that was not used in any other Large Mart activities;

Total interest payments made by Large Mart during the construction of the factory of $100,000. Of this amount $16,000 relate to a loan (with an overall loan value of $300,000 and a repayment duration of 5 years) that Large Mart took out to finance components used in the factory’s production line. The remaining interest payments during this time related to a different loan that was used to purchase an office building in a previous year.

The CFO is not sure how to treat these expenditures in the books of Large Mart, and has asked you to investigate, and write a report about, the following questions:

a)     What are the accounting requirements for reporting entities in Australia regarding the accounting treatment(s) of the depreciation that was calculated by the Finance Department (your report should NOT discuss different methods to calculate depreciation!!!)? In your answer you should discuss (1) what relevant requirements exist in relation to the accounting treatment(s) of all components of the depreciation calculated by the Finance Department, and (2) how Large Mart should apply these requirements in the given situation. (500 Words)

b)     What are the accounting requirements for reporting entities in Australia regarding the accounting treatment(s) of all components of the interest expenditures calculated by the finance department? In your answer, you should discuss (1) what relevant requirements exist in relation to the accounting treatment(s) of all components of the interest calculated by the Finance Department, and (2) why the accounting treatment(s) you have identified are required in the given situation. (500 Words)

Answer 1

According to the accounting standards accepted internationally and also in Australia, it allows the expenses incurred by the organisation to be fully capitalised if the organisation is able to identify the expenses incurred specifically for the project/building.

1. As per the requirements of reporting entities in Australia regarding the accounting treatment of all components of the depreciation as calculated by the finance department

Depreciation amount is $30,000 out of which $20,000 being specifically incurred for the machinery acquired for the new project and as per the accounting standards till the plant is ready to use. The whole of the depreciation can be capitalised to the cost of project and depreciation on the cost will be allowed as per the depreciation policy followed by the organisation.

For the part 2 of the question the logic will be covered by the same accounting standard.

The specific interest cost incurred for the loan taken by the organisation to finance the components to be used in the project the same shall be capitalised to the full extent till the project becomes operational.

The important part is that interest cost has different impact than that of depreciation, apart from the specific interest cost the company also has to apportion the part of interest cost on the funds borrowed for general purpose.

But since no specific details are given in this particular question related to general loan no such cost will be capitalized and only $16,000 will be.

So the total amount to be capitalised with the new factory will be $16,000 and $20,000 = $36,000