Question

arly in its fiscal year ending December 31, 2018, San Antonio Outfitters finalized plans to expand operations. The first stage was completed on March 28 with the purchase of a tract of land on the outskirts of the city. The land and existing building were purchased for $1,200,000. San Antonio paid $400,000 and signed a noninterest-bearing note requiring the company to pay the remaining $800,000 on March 28, 2020. An interest rate of 9% properly reflects the time value of money for this type of loan agreement. Title search, insurance, and other closing costs totaling $40,000 were paid at closing.
   
During April, the old building was demolished at a cost of $90,000, and an additional $70,000 was paid to clear and grade the land. Construction of a new building began on May 1 and was completed on October 29. Construction expenditures were as follows: (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

May 1	$	4,200,000
July 30		2,500,000
September 1		2,100,000
October 1		3,000,000

San Antonio borrowed $6,700,000 at 9% on May 1 to help finance construction. This loan, plus interest, will be paid in 2019. The company also had the following debt outstanding throughout 2018:

$4,000,000, 10% long-term note payable

$6,000,000, 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 $800,000. The fair values of the equipment and the furniture and fixtures were $675,000 and $225,000, respectively. In December, San Antonio paid a contractor $385,000 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

a)
Land
Cash Paid	$                  400,000.00
Present value of note payable = $800,000 x PV(9%,2)	$673,343.99
Purchase Price of land ($400,000 + $673,344)	$               1,073,343.99
Add: Closing Cost	$                    40,000.00
Removal of old building	$                    90,000.00
Clearing and grading	$                    70,000.00
Initial Cost of Land	$                    1,273,344
Building
Construction Expenditures
1-May	$               4,200,000.00
30-Jul	$               2,500,000.00
1-Sep	$               2,100,000.00
1-Oct	$               3,000,000.00
Total expenditures		$   11,800,000.00
Capitalized interest (Calculated Below)		$        299,250.00
Initial  cost of Building		$   12,099,250.00
Accumulated Expenditures
Payment Date	Expenditures (A)	Capitalization Period (B)	Weight (C=B/6)	Weighted Expenditures (A×C)
1-May	$               4,200,000.00	6	100.00%	$     4,200,000.00
30-Jul	$               2,500,000.00	3	50.00%	$     1,250,000.00
1-Sep	$               2,100,000.00	2	33.33%	$        700,000.00
1-Oct	$               3,000,000.00	1	16.67%	$        500,000.00
Total				$     6,650,000.00
Interest Capitalized = $6,650,000 x 9% x 6/12	$                  299,250.00
Equipment and Office furniture and fixtures
	Fair value	Percent of total fair value	Initial Valuation = % x $800,000
Equipment	$                  675,000.00	75.00%	$            600,000.00
Office furniture and fixtures	$                  225,000.00	25.00%	$            200,000.00
Total	$                  900,000.00	100.00%	$            800,000.00
Land Improvements
Parking lots and Landscaping	$                  385,000.00
Initial cost of Land Improvements	$                  385,000.00
b)
Interest expense will San Antonio report in its 2016 income statement
Notes issued to purchase land and building =$673,344 x 6% x 9/12	$                    45,450.72
Construction loan (6,700,000 x 9% x 8/12)	$                  402,000.00
Long-term note ( 4,000,000 x 10%)	$                  400,000.00
Long-term bonds (6,000,000 x 7%)	$                  420,000.00
Total	$               1,267,450.72
Less; Interest capitalized	$                 (299,250.00)
Interest expense reported 2018  income statement	$                  968,200.72