Question

#1.Stargazer Company was incorporated on January 1, 2015 but was unable to begin manufacturing activities until July 1, 2015, because new factory facilities were not completed until that date. The Land and Building account reported the following items during 2015:

January 31                                                       Land and buildings                          $160,000

February 28                                                     Cost of removal of building                 9,800

May 1                                                              Partial payment of new construction     60,000

May 1                                                              Legal fees paid                                     3,770

June 1                                                              Second payment on new construction 40,000

June 1                                                              Insurance premium                              2,280

June 1                                                              Special tax assessment                          4,000

June 30                                                            General expenses                                 36,300

July 1                                                               Final payment on new construction     30,000

December 31                                                   Asset write up                                      53,800

                                                                                                                                    399,950

December 31                                                   Depreciation – 2015 at 1%                  (4,000)

December 31, 2015                                         Account balance                                  395,950

The following additional information is to be considered:

1. To acquire land and building, the company paid $80,000 cash and 800 shares of its 8% cumulative preferred stock, par value $100 per share. Fair value of the stock is $117 per share.

2. Cost of removal of old buildings amounted to $9,800, and the demolition company retained all materials of the building.

3. Legal fees covered the following:

Cost of organization $610

Examination of title covering purchase of land1,300

Legal work in connection with construction contract1,860

                                                                                    3,770

4. Insurance premium covered the building for a 2 year term beginning May 1, 2015.

5. The special tax assessment covered street improvements that are permanent in nature.

6. General expenses covered the following for the period from Jan 1 to June 30, 2015.

President’s salary$32,100

Plant superintendent’s salary – supervision of new building4,200

                                                                                                36,300

7. Because of a general increase in construction costs after entering into the building contract, the board of directors increased the value of the building $53,800, believing that such an increase was justified to reflect the current market at the time the building was completed. Retained earnings was credited for this amount.

8. Estimated life of building – 50 years. Depreciation for 2015 – 1% of asset value (1% of $400,000 or $4,000)

Provide entries to reflect correct land, buildings and depreciation accounts at December 31, 2015. I would recommend you show detailed calculations to receive partial credit.

#2. You have a client that is considering trading machinery with another company. Although the machines are different from each other, you believe that an assessment of expected cash flows on the exchanged assets will indicate the exchange lacks commercial substance. Your client would prefer that the exchange be deemed to have commercial substance, to allow them to record gains. Here are the facts:

                                                                                                Your Client    Other Company

Original cost                                                                            $150,000         $100,000

Accumulated depreciation                                                       80,000             40,000

Fair value                                                                                 100,000           80,000

Cash received (paid)                                                                20,000             (20,000)

Record the entry on your client’s books assuming the exchange LACKS commercial substance. Then discuss what the financial statement effects would be of treating the exchange as having, versus lacking, commercial substance.

#3.Your client is in the planning phase for a major plant expansion, which will involve the construction of a new warehouse. The assistant controller does not believe that interest cost can be included in the cost of the warehouse because it is a financing expense. Others on the planning team believe that some interest cost can be included in the cost of the warehouse, but no one could identify the specific authoritative guidance for this issue. Your supervisor asks you to research this issue.

Using the FASB codification, answer the following questions (you must quote from the codification and include the section/paragraphs to receive credit).

a)What are the objectives for capitalizing interest?

b) Which assets qualify for interest capitalization?

c) Is there a limit to the amount of interest that may be capitalized in a period?

d) If interest capitalization is allowed, what disclosures are required?

Answer 1

Answer 2. Treatment if the Exchange Lacks Commercial Substance:-

Your Client would be prohibited from recogninzing $20,000 gain on exchange. This is because the transaction lacks commercial substance. The new asset on their book would have a basis of $ 1,30,000 ($1,50,000- $20,000 unrecognised gain). The Entry would be as follows:-

Machinery ($ 80,000 - $ 30,000)........................ $ 50,000

Accumulated Depreciation - Machinery...............$ 80, 0000

Cash ........................................ $ 20,000

Machinery.................................. $ 1,50,000

Book Value :- $1,50,000

Less: Accu. Dep $80,000

= $70,000 Compared to Fair Value of Machinery $1,00,000

Gain on disposal = $30,000

Vs

Having Commericial Substance

Machinery................................. $ 80,000

Accummulated Dep. .................$ 80,000

Cash .........................................$ 20,000

Machinery.......................................... $ 1,50,000

Gain on Disposal of Machinery....................... $ 30,000

ANSWER 3 (A). The objective of capitalizing interest is to obtain a measure of acquisition cost that reflects a company's total investment in the asset and to charge that cost to future periods benefited.

ASC 835-20-10-1 strictly defines the objectives of capitalizing interest are, “to obtain a measure of acquisition cost that more closely reflects an entity’s total investment in the asset and to charge a cost that relates to the acquisition of a resource that will benefit future periods against the revenues of the periods benefited. ASC 835-20-10-2 goes on to further define the objectives in terms of historical cost of acquiring an asset as it should, “include all costs necessarily incurred to bring it to the condition and location necessary for its intended use.

(B). Qualifying Assets:- To qualify for interest capitalization, assets must require a period of time to get them ready for theirintended use.A company capitalizes interest costs starting with the first expenditure related to the asset. Capitalization continues until the company substantially readies the asset for its intended use.Assets that qualify for interest cost capitalization include assets under construction for a company's own use (includingbuildings, plants, and large machinery) and assets intended for sale or lease that are constructed or otherwise produced asdiscrete projects (e.g., ships or real estate developments).

Examples of assets that do not qualify for interest capitalization are:-

(1) assets that are in use or ready for their intendeduse, and

(2) assets that the company does not use in its earnings activities and that are not undergoing the activities necessary to get them ready for use. Examples of this second type include land remaining undeveloped and assets not used because of obsolescence, excess capacity, or need for repair.

Answer (C) :- Yes, there is limit to the amount of interest to be capitalized in a period.The amount of interest to capitalize is limited to the lower of actual interest cost incurred during the period or avoidable interest. Avoidable interestis the amount of interest cost during the period that a company could theoretically avoid if ithad not made expenditures for the asset. To apply the avoidable interest concept, a company determines the potential amount of interest that it may capitalize during an accounting period by multiplying the interest rate(s) by the weighted-average accumulated expendituresfor qualifying assets during the period.

Answer (D):- Capitalizing interest is an important aspect in a company’s accounting information. It is the only way for a company to correctly recognize the actual costs of their assets. If a company fails to do so it can be detrimental not only to the entity’s current operations but in future accounting periods as well due to the fact that it will reduce reported earnings during the current period in which the assets were acquired and in turn decrease reported earnings reported earnings in later periods.

After the entity has gone through all of the preceding steps and requirements they must finish the process by disclosing the pertinent information in their financial statements. To determine what information shall be disclosed the entity must look up ASC 835-20-50-1 in the codification which states that an entity “shall disclose the following information with respect to interest cost in the financial statements or related notes:

a)For an accounting period in which no interest cost is capitalized, the amount of interest cost incurred and charged to expense during the period

b)For an accounting period in which some interest cost is capitalized, the total amount of interest cost incurred during the period and the amount thereof that has been capitalized.”