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Financial Accounting: capitalization of interest on PPE

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Capitalization of Interest

Wordcrafters Inc. is a book distributor that had been operating in its
original facility since 1982. The increase in certification programs and continuing education requirements
in several professions has contributed to an annual growth rate of 15% for Wordcrafters since 2002. Wordcraftersâ??
original facility became obsolete by early 2007 because of the increased sales volume and the fact
that Wordcrafters now carries tapes and disks in addition to books.
On June 1, 2007, Wordcrafters contracted with Favre Construction to have a new building constructed
for $4,000,000 on land owned by Wordcrafters. The payments made by Wordcrafters to Favre Construction
are shown in the schedule below.
Date Amount
July 30, 2007 $1,200,000
January 30, 2008 1,500,000
May 30, 2008 1,300,000
Total payments $4,000,000

Acquisition and Disposition of Property, Plant, and Equipment
Construction was completed and the building was ready for occupancy on May 27, 2008. Wordcrafters
had no new borrowings directly associated with the new building but had the following debt outstanding
at May 31, 2008, the end of its fiscal year.
141�2%, 5-year note payable of $2,000,000, dated April 1, 2004, with interest payable annually on April 1.
12%, 10-year bond issue of $3,000,000 sold at par on June 30, 2000, with interest payable annually on
June 30.
The new building qualifies for interest capitalization. The effect of capitalizing the interest on the new
building, compared with the effect of expensing the interest, is material.
Instructions
(a) Compute the weighted average accumulated expenditures on Wordcraftersâ?? new building during
the capitalization period.
(b) Compute the avoidable interest on Wordcraftersâ?? new building.
(c) Some interest cost of Wordcrafters Inc. is capitalized for the year ended May 31, 2008.
(1) Identify the items relating to interest costs that must be disclosed in Wordcraftersâ?? financial
statements.
(2) Compute the amount of each of the items that must be disclosed.

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Solution Preview

a.
Dates Amount Capitalized Period Weighted Average Accumulated Expenditures
July 30, 2007 1,200,000 6/12(.50) 600,000
January 30, 2008-1,500,000 4/12(.33) 495,000
May 30, 2008 1,300,000 0/12(0) 0
1,095,000
The table shows the computation of the weighted average accumulated expenditures. First take the dates and amounts of the payments of the loan. Then figure out the capitalized period by adding how many months in a year does it take between the first and second payment, the second and third payment and the last payment before the construction is finished. Multiply the amount paid times the ...

Solution Summary

Capitalization of interest on PPE is examined.

$2.19
See Also This Related BrainMass Solution

Accounting: 41 Multiple choice questions

You are trying to determine which of two companies is the most profitable. Which of the following would be the best indicator of relative profitability?
A) highest net income
B) highest retained earnings
C) highest return on equity
D) highest income from continuing operations

2. Which of the following would not be considered a source of financing?
A) notes receivable
B) common stockholders' equity
C) retained earnings
D) capital lease obligations

3. Will Company reports the following:
2009 2008
Retained Earnings $2,000,000 $ 1,300,000
Common Stock $ 500,000 $ 500,000
Paid-in Capital $3,000,000 $ 3,000,000
Net Income for year $ 900,000 $ 400,000

Dividend payout ratio for 2009 was:
A) 12%
B) 18.7%
C) 22.2%
D) 27%

4. If a company receives an unqualified audit opinion it means the auditors
A) did not complete a full audit and therefore do not feel qualified to give and opinion on financial statements.
B) are providing assurance that the company will remain financially viable for at least the next year.
C) are providing assurance that the company's financial statements fairly present company's financial performance and position.
D) are providing assurance that the company's financial statements are free from misstatement, fraudulent accounting and fairly indicate future performance.

5. The Management Discussion and Analysis Section of the annual report:
A) is required by the SEC
B) is optional but normally included in the annual report
C) is required by the SEC only if the company has suffered from unfavorable trends or there are significant uncertainty concerning liquidity of the company
D) is required by the SEC only if they have a qualified audit opinion

6. To estimate the intrinsic values of an equity or debt security using present value
theory you need to know
A) the yield to maturity.
B) a discount rate and the expected payoffs over the life of the security.
C) the probability of the expected future payoffs over the life of the security.
D) the current market value of the equity or debt security.

7. Which of the following is not a common tool used in financial statement analysis?
A) random walk analysis
B) ratio analysis
C) common size statement analysis
D) trend series analysis

8. A common size income statement would typically be prepared by dividing:
A) All items on income statement in Year t by their corresponding value in Year t-1
B) All items on income statement in Year t by their corresponding balance sheet account in Year t
C) All items on income statement in Year t by net income in Year t-1
D) All items on income statement in Year t by sales in Year t

9. You are examining the common size income statements of two companies, A and B, for 2011. This data is most likely to help you answer which of the following questions?
A) Which company had the largest net income.
B) Which company utilized its assets most efficiently.
C) Which company had the highest gross margin ratio.
D) Which company had the biggest increase in sales from the prior year.

10. Which of the following statements concerning financial ratios is incorrect?
A) accounting principles and methods used by a company will not affect financial ratios
B) the informational value of a ratio in isolation is limited
C) a ratio is one number expressed as a percentage or fraction of another number
D) calculation of financial ratios is not sufficient for a complete financial analysis of a company

11. Which of the following is (are) a change(s) in accounting principle?

I. a change from LIFO to FIFO
II. a change in estimated salvage value of depreciable asset
III. a change from straight line to sum-of-the-years digits
IV. recording depreciation for first time on machinery purchased five years
ago

A) I, II, III and IV
B) I, II and III
C) I and II
D) I

12. If a company fails to record a material amount of depreciation in a previous year, this is considered:
A) a change in accounting principle
B) an unusual item
C) an accounting error
D) a change in estimate

13. Which of the following are examples of judgments made in the accounting reporting process?

I. Useful life of machinery
II. Allowance for doubtful accounts
III. Obsolescence of assets
IV. Classification of investments as available for sale or trading securities.

A) I, II, III and IV
B) I, II and III
C) II and III
D) I and III

14. Which of the following would affect the comparability of accounting information for a given company from one accounting period to the next?

I. Change in accounting principles
II. Disposition of segment of business
III. Restructuring expense
IV. Change in auditors

A) I and II
B) I and III
C) I, II and III
D) I, III and IV

15. When analyzing financial statements it is important to recognize that accounting distortions can arise. Accounting distortions are those things that cause deviations in accounting information from the underlying economics. Which of the following statements is not correct? Accounting distortions:
A) can arise as management may deliberately manipulate financial statements
B) arise often through application of (correct) accounting principles
C) can affect the quality of earnings
D) arise because the stock market is not efficient

16. The two secondary qualities of accounting information to make it useful for decision making are:
A) Consistency and Comparability
B) Relevance and Reliability
C) Materiality and Comparability
D) Full Disclosure and Relevance

17. When considering cash versus accrual accounting, which of the following statements is correct?
A) neither cash flows nor net income can be manipulated
B) net income cannot be manipulated but cash flows can
C) both cash flows and net income can be manipulated
D) cash flows cannot be manipulated but net income can be manipulated

18. Which one of the following is not an example of a red flag, used to evaluate earnings quality?
A) Qualified audit report
B) Net income this year is higher then net income last year
C) Poor financial performance
D) Frequent or unexplained changes in accounting policies

19. Which of the following is not considered part of GAAP?
A) Statements of Financial Accounting Standards (SFAS)
B) International Accounting Standards (IAS)
C) Accounting Research Bulletins (ARB).
D) Accounting Principles Board Opinions (APB).

20. Which of the following is not considered a monitoring mechanism?
A) The Securities and Exchange Commission (SEC)
B) Top level management
C) The board of director's audit committee
D) The external auditors

Use the following to answer questions 21 and 22:

Cleveland Company reports the following information as of 12/31/2012:

-10% cumulative preferred stock, par value
$100, One-year of dividends in arrears; 20,000
shares authorized; issued, 10,000 shares;
$1,000,000

0
-Common stock - authorized 500,000; 40,000
outstanding; $2 par value - $80,000

Additional paid-in-capital - $450,000
-Retained Earnings - $2,000,000

21. The book value per share of common stock is:
A) $57.75
B) $60.25
C) $60.75
D) $63.25

22. The book value per share of preferred stock is:
A) $ 100
B) $ 110
C) $ 112
D) $ 116

23. Hurt Corporation acquired a capital lease that is carried on its books at a present value of $100,000 (discounted at 12%). Its' annual lease payment is $15,000. What is the amount of interest expense from this lease?
First Year Second Year
A) 12,000 10,200
B) 12,000 11,640
C) 12,000 12,350
D) 15,000 15,000

24. Recording a long-term lease as an operating lease, as opposed to a capital lease, for a lessee will cause the following ratios to be:
Debt/Equity Total Asset Turnover
A) Higher Lower
B) Higher Higher
C) Lower Higher
D) Lower Lower

25. If a company leases equipment to other companies and records these leases as operating leases rather than a capital leases, its (the lessor's):

I. recorded liabilities will be lower
II. recorded assets will be higher
III. total cash flows will be higher
IV. leverage ratios will be higher

A) I and III
B) II and IV
C) I only
D) II, III and IV

26. After the adoption of SFAS 158, the pension asset/liability on a company's books will be equal to
A) The difference between the projected benefit obligation and the fair value of
the plan assets.
B) The difference between the pension expense and the amount funded during
the current year.
C) The pension expense and the projected benefit obligation for any given year,
less the amount funded.
D) The fair value of the plan assets less the unamortized prior service cost, plus
any unamortized gains minus any unamortized losses.

27. Capitalizing interest costs will have which of the following effects on a company's financial statements after the initial period?
A) Net earnings will be lower.
B) Current ratio will increase.
C) Total debt will be lower.
D) Pretax cash flow will be lower.

28. Which of the following is not a component of pension expense under defined benefit plans?
A) Service cost
B) Amortization of prior service costs
C) Interest cost
D) Amortization of prior interest costs

29. For a company with a current ratio of less than 1.0, which of the following accounting actions is most likely to increase its current ratio?
A) Sell property, plant, or equipment for cash.
B) Making cash payments on accounts payable.
C) Paying off long-term debt.
D) Leasing equipment under a long-term capital lease agreement.

30. A company's current assets are $150 and its' current liabilities are $100. If the company uses cash to retire notes payable due within one year, would this transaction increase or decrease the current ratio and return on assets ratio?
A) Current Ratio: Increase; Return on Assets: Increase
B) Current Ratio: Increase; Return on Assets: Decrease
C) Current Ratio: Decrease; Return on Assets: Increase
D) Current Ratio: Decrease; Return on Assets: Decrease

Use the following information to answer questions 31 and 32

Control Furniture Company
Annual Report Excerpts
(Figures in thousands of dollars)

December 31 2015 2016

Inventories at FIFO Cost 846.3 852.6
Excess of FIFO Cost over LIFO Cost (231.4) (257.2)
Inventories at LIFO Cost 614.9 595.4

Income Tax rate is 34%
Answers are rounded to the nearest decimal point.

31. Given the financial information presented above what would be the effect on cash in 2015 of converting the company from LIFO to FIFO:
A) Increase of 78.7
B) Decrease of 78.7
C) Decrease of 152.7
D) Increase of 152.7

32. Given the financial information presented above what would be the effect on net income before taxes in 2016 of converting the company from LIFO to FIFO:
A) Increase of 257.2
B) Decrease of 257.2
C) Increase of 174.9
D) Decrease of 174.9

33. HTGT Inc. has a defined contribution pension plan for its employees. Under this type of plan which best describes the contingent liability associated with the plan?
A) HTGT has a contingent liability until the employee retires.
B) HTGT has a contingent liability until the employee dies.
C) HTGT has no contingent liability.
D) The employee has a contingent liability.

34. Captain Inc. purchases a depreciable asset for $100,000. The life of the asset is 10
years and it has an estimated salvage value of $10,000. Captain Inc. takes a full
year of depreciation expense in the year the asset is acquired. Which of the
following statements is true?
A) In year three using straight-line depreciation the amount will be $10,000.
B) Changing depreciation methods in year four will be considered a change in accounting principle.
C) Depreciation under the double-declining method (200%) in year one will be equal to $18,000.
D) Changing depreciation methods in year two will require prospective application.

35. Which of the following is not an effect of capitalization?
A) Capitalization usually reduces net income
B) Capitalization usually yields a smoother net income
C) Capitalization usually decreases the volatility of the return on investment
D) Capitalization usually increases net income

36. Companies are supposed to write-down value of assets if a permanent impairment of value or loss of utility occurs. If a company writes down its assets this year the effect on:
This year's ROA Next year's ROA
A) Increased No change
B) Decreased No change
C) Decreased Decreased
D) Decreased Increased

37. Under current US GAAP, goodwill is:
I. amortized over a period not to exceed 40 years
II. tested annually for impairment
III. exclusive of separately identifiable intangible assets
IV. recorded only upon purchase of another entity

A) I, II, III and IV
B) II, III and IV
C) I, II and III
D) II and IV

38. Which of the following scenarios reflects the correct application of U.S. GAAP for capitalization of certain expenditures as intangible assets?
A) A company's marketing department researches, develops and promotes a completely new name, packaging and design for its main product line, capitalizing $1.8 million in related costs. Previously, the brand had remained unchanged for 45 years.
B) A pharmaceutical company capitalizes cost of $47 million after 5 years of researching and developing a new hair growth pill.
C) A company capitalizes $12 million of research and development costs incurred during the most recent operating cycle.
D) A software company capitalizes $3.9 million in development costs after a working model of its newest product is completed. It is beyond the beta testing stage.

39. AVPR Company sets up a qualifying SPE to sell their accounts receivable (A/R) to the SPE. The SPE meets the unconsolidated requirement under GAAP. The most likely outcome of using the SPE by AVPR will be to
A) improve operating performance ratios of AVPR.
B) have AVPR recognize gains on the sale of their A/R to the SPE.
C) have the SPE issue debentures.
D) be a greater cost of financing to AVPR than borrowing funds from the credit markets.

40. Financial Statements of ABC Corp. indicates that ending inventory levels in 2010 and 2011 were $200,000 and $350,000 respectively. Net Sales for 2010 and 2011 were $5,000,000 and $5,500,000 respectively. Cost of Goods sold for 2010 and 2011 were $1,900,000 and $2,200,000 respectively. Purchases are recorded using the net method and purchase discounts lost are expensed. Purchase discounts lost in 2010 and 2011 were $50,000 and $75,000 respectively. Purchases in 2011 were:
A) $2,225,000
B) $2,275,000
C) $2,350,000
D) $2,425,000

41. The YC Company is having liquidity problems. Their current ratio is .80. Which of the following will improve their current ratio in the short-term?
A) Establish a petty cash fund.
B) Selling inventory at less than cost to raise cash.
C) Borrowing money, payable in three years.
D) Offering sales discounts on their current accounts receivable for faster receipt of cash.

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