Unit 2 Questions Flashcards
Acquisition and Disposition of Property, Plant, and Equipment
How does GAAP recommend accounting for interest costs incurred during construction?
Capitalize the actual interest cost for the period incurred during the period
Note: Correct. Using this approach ignores the implicit interest cost associated with the use of the cash. GAAP requires only the actual interest costs incurred during construction be capitalized. This method follows the historical cost principle.
What assets qualify for interest cost capitalization?
Assets that are under construction for a company’s own use
Note: Correct. For the purposes of interest cost capitalization, qualifying assets must require a period of time to get the asset ready for their intended purposes. Assets that do not qualify include assets that are currently in use, assets that are ready for their intended use, or assets that are not in use due to excess capacity or obsolescence.
When computing the amount of interest cost to be capitalized, What does the concept of “avoidable interest” refer to?
That portion of total interest cost which would not have been incurred if expenditures for asset construction had not been made
Note: Correct. Avoidable interest is the amount of interest cost during the period that a company could theoretically avoid if it had not made the decision to purchase the asset in the first place.
What best describes the correct treatment of the interest costs capitalized during the period of construction when a company purchases land as a site for a plant?
Regard as a cost of the plant
Note: Correct. Interest costs may only be included in the cost of qualifying assets, or assets that are constructed for the company’s own use and those assets intended to be sold/leased. Interest costs are not allocated to assets that are ready for their intended use already or assets that are not used in the company’s earnings activities, such as land or assets otherwise not in use.
On January 2, 2020, Indian River Groves began construction of a new citrus processing plant. The automated plant was finished and ready for use on September 30, 2021. Expenditures for the construction were as follows:
January 2, 2020 $ 600,000
September 1, 2020 $1,800,000
December 31, 2020 $1,800,000
March 31, 2021 $1,800,000
September 30, 2021 $1,200,000
Indian River Groves borrowed $3,300,000 on a construction loan at 12% interest on January 2, 2020. This loan was outstanding during the construction period.
$1,200,000
Note: calculated as: ($600,000 × 12/12) + ($1,800,000 × 4/12) + ($1,800,000 × 0/12) = $1,200,000.
On January 2, 2020, Indian River Groves began construction of a new citrus processing plant. The automated plant was finished and ready for use on September 30, 2021. Expenditures for the construction were as follows:
January 2, 2020 $ 600,000
September 1, 2020 $1,800,000
December 31, 2020 $1,800,000
March 31, 2021 $1,800,000
September 30, 2021 $1,200,000
Indian River Groves borrowed $3,300,000 on a construction loan at 12% interest on January 2, 2020. This loan was outstanding during the construction period.
What was the capitalized interest for 2020?
$144,000
Note: Correct. The amount of interest to capitalize is based on the weighted-average of the accumulated expenditures. The weighted-average accumulated expenditures for 2020 is calculated as: ($600,000 × 12/12) + ($1,800,000 × 4/12) + ($1,800,000 × 0/12) = $1,200,000. Capitalized interest is calculated as: $1,200,000 × 12% = $144,000.”
Watauga Company had the following events:
Purchase of equipment on July 1, 2017 for $70,000
Sales tax on the purchase was $700
Other costs of freight charges of $800
Insurance during shipping of $ 150
Repairs of $1,300 for damage during installation
Installation costs of $1, 050
What is the cost of the equipment?
$72,700
Note: Correct. The cost of a piece of equipment includes all expenditures incurred in acquiring the equipment and preparing it for use. Therefore the cost includes the cost of $70,000, sales tax of $700, freight charges of $800, insurance of $ 150, and installation costs of $1,050. The repair costs of $1,300 are expensed and not included in the capitalized cost of the equipment.
Cotton Hotel Corporation recently purchased Emporia Hotel and the land on which it is located with the plan to tear down the Emporia Hotel and build a new luxury hotel on the site.
How should the cost of the Emporia Hotel be treated?
Capitalized as part of the cost of the land
Note: Correct. If a company purchases land with an old building on it, then the cost of demolition less its salvage value is a cost of getting the land ready for its intended use and relates to the land rather than to the new building. Therefore, the cost of the Emporia hotel is capitalized as part of the cost of the land.
How are fences and parking lots reported on the balance sheet?
Land improvements
Note: Correct. Improvements with limited lives, such as driveways, walks, fences, and parking lots are classified on the balance sheet as Land Improvements and depreciated over their estimated lives.
Land was purchased to be used as the site for the construction of a plant. A building on the property was sold and removed by the buyer so that construction on the plant could begin.
‘How should the proceeds from the sale of the building be treated?
Deducted from the cost of the land
Note: Correct. If a company purchases land with an old building on it, then the cost of demolition less its salvage value is a cost of getting the land ready for its intended use and relates to the land rather than to the new building. Therefore, the proceeds from the sale of the old building is deducted from the cost of the land.
Wilson Co. purchased land as a factory site for $1,350,000.
Wilson paid $120,000 to tear down two buildings on the land.
Salvage was sold for $8,100.
Legal fees of $5,220 were paid for title investigation and making the purchase.
Architect’s fees were $46,800. Title insurance cost $3,600, and liability insurance during construction cost $3,900.
Excavation cost $15,660.
The contractor was paid $4,200,000.
An assessment made by the city for pavement was $9,600.
At what cost should Wilson Co record the land?
$1,480,320
Note: Correct. Removal of old buildings—clearing, grading, and filling—is a land cost because this activity is necessary to get the land in condition for its intended purpose. Architect Fees, liability insurance, and excavation are included in the cost of the building. Therefore, the cost of the land is calculated as: $1,350,000 + $120,000 – $8,100 + $5,220 + $3,600 + $9,600 = $1,480,320. The excavation cost of $15,660 is a cost related to the building, not to the acquisition of the land, as the excavation cost is directly related to building the building on the land.
How does GAAP recommend accounting for interest costs incurred during construction?
Capitalize the actual interest cost for the period incurred during the period
Correct: Using this approach ignores the implicit interest cost associated with the use of the cash. GAAP requires only the actual interest costs incurred during construction be capitalized. This method follows the historical cost principle.
What assets qualify for interest cost capitalization
Assets that are under construction for a company’s own use
Correct. For the purposes of interest cost capitalization, qualifying assets must require a period of time to get the asset ready for their intended purposes. Assets that do not qualify include assets that are currently in use, assets that are ready for their intended use, or assets that are not in use due to excess capacity or obsolescence.
When computing the amount of interest cost to be capitalized, What does the concept of “avoidable interest” refer to?
That portion of total interest cost which would not have been incurred if expenditures for asset construction had not been made
Correct. Avoidable interest is the amount of interest cost during the period that a company could theoretically avoid if it had not made the decision to purchase the asset in the first place.
On January 2, 2020, Indian River Groves began construction of a new citrus processing plant. The automated plant was finished and ready for use on September 30, 2021. Expenditures for the construction were as follows:
January 2, 2020 $ 600,000
September 1, 2020 $1,800,000
December 31, 2020 $1,800,000
March 31, 2021 $1,800,000
September 30, 2021 $1,200,000
Indian River Groves borrowed $3,300,000 on a construction loan at 12% interest on January 2, 2020. This loan was outstanding during the construction period.
What were the weighted-average accumulated expenditures for 2020?
$1,200,000
Correct. The weighted-average accumulated expenditures for 2020 is calculated as: ($600,000 × 12/12) + ($1,800,000 × 4/12) + ($1,800,000 × 0/12) = $1,200,000.
