P 10-12 acquisition costs; lump-sum acquisition; noninterest-bearing

P 10-12 Acquisition costs; lump-sum acquisition; noninterest-bearing note; interest capitalization
 
P 10-12  Early in its fiscal year ending December 31, 2011, 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 $800,000. San Antonio paid $200,000 and signed a noninterest-bearing note requiring the company to pay the remaining $600,000 on March 28, 2013. An interest rate of 8% properly reflects the time value of money for this type of loan agreement. Title search, insurance, and other closing costs totaling $20,000 were paid at closing.
 
During April, the old building was demolished at a cost of $70,000, and an additional $50,000 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:
 
May 30             $1,200,000
July 30             1,500,000
September 1     900,000
October 1         1,800,000
 
San Antonio borrowed $3,000,000 at 8% on May 1 to help finance construction. This loan, plus interest, will be paid in 2012. The company also had the following debt outstanding throughout 2011:
 
$2,000,000, 9% long-term note payable
$4,000,000, 6% 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 $600,000. The fair values of the equipment and the furniture and fixtures were $455,000 and $245,000, respectively. In December, San Antonio paid a contractor $285,000 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 2011. 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 2011 income statement?
 
Problem 10-12
Requirement 1
            Land
            Purchase price (determined below)                   $714,404
            Closing costs                                                          20,000
            Removal of old building                                      70,000
            Clearing and grading                                           50,000
                                                                                          $854,404
            Purchase price of land:
                 Cash paid                                                      $200,000
                 Value of note†                                                514,404
                                                                                          $714,404
            † Present value of note payment:
            PV = $600,000 (.85734)  = $514,404
          Present value of $1: n = 2, i = 8% (from Table 2)
 
            Land improvements
            Parking lot and landscaping                          $285,000
            Building
          Construction expenditures:
                   May 30                                      $1,200,000
                   July 30                                         1,500,000
                   September 1                                    900,000
                   October 1                                     1,800,000
                      Total expenditures                     5,400,000
          Interest capitalized (determined below)               94,000
               Total cost of building                      $5,494,000
 
 
 
 
 
            Average accumulated expenditures:
            May 31, 2011                $1,200,000  x   5/6  =    $ 1,000,000
            July 30, 2011                   1,500,000  x   3/6  =           750,000
            September 1, 2011           900,000  x   2/6  =           300,000    
            October 1, 2011             1,800,000  x   1/6  =           300,000
                                                                                                  $2,350,000
 
            Interest capitalized:
            $2,350,000 x 8% x 6/12 =                                             $94,000
Equipment and furniture and fixtures
                                                                                                                          Initial
                                                                             Percent of Total             Valuation
                                               Fair Value                 Fair Value                % x $600,000
Equipment                            $455,000                        65%                       $390,000
Furniture & fixtures              245,000                       35%                          210,000
            Totals                         $700,000                     100%                       $600,000
 
 
Initial valuation:
Equipment                           $390,000
Furniture & fixtures             210,000
Requirement 2
 
Interest expense:
      Note issued to purchase land and building,
          $514,404 x 8% x 9/12 =                                                $  30,864
      Construction loan, $3,000,000 x 8% x 8/12                  160,000
      Long-term note, $2,000,000 x 9%                                   180,000
      Long-term bonds, $4,000,000 x 6%                                240,000
           Total                                                                                   610,864
      Less: Interest capitalized (determined above)             (94,000)
Interest expense                                                                      $516,864
 
 
 Assignment: Create a General Journal from the information above