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Compute avoidable interest

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1. Brett Hull Company is constructing a building. Construction began on February 1 and was completed
on December 31. Expenditures were $1,500,000 on March 1, $1,200,000 on June 1, and $3,000,000
on December 31 Brett Hull Company borrowed $1,000,000 on March 1 on a 5-year, 12% note to help
finance construction of the building. In addition, the company had outstanding all year a 13%, 5-year,
$2,000,000 note payable and a 15%, 4-year, $3,500,000 note payable.
Compute avoidable interest for Brett Hull Company.

2. Callaway Golf Co. leases telecommunication equipment. Assume the following data for equipment
leased from Photon Company. The lease term is 5 years and requires equal rental payments of $30,000
at the beginning of each year. The equipment has a fair value at the inception of the lease of $138,000, an
estimated useful life of 8 years, and no residual value. Callaway pays all executory costs directly to third
parties. Photon set the annual rental to earn a rate of return of 10%, and this fact is known to Callaway.
The lease does not transfer title or contain a bargain purchase option. How should Callaway classify this
lease?

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1. Brett Hull Company is constructing a building. Construction began on February 1 and was completed on December 31. Expenditures were $1,500,000 on March 1, $1,200,000 on June 1, and $3,000,000 on December 31 Brett Hull Company borrowed $1,000,000 on March 1 on a 5-year, 12% note to help finance construction of the building. In addition, the company had outstanding all year a 13%, 5-year, $2,000,000 note payable and a 15%, 4-year, $3,500,000 note payable.
Compute avoidable interest for Brett Hull Company.

2. Callaway Golf Co. leases telecommunication equipment. Assume the following data for equipment
leased from ...

Solution Summary

The solution computes avoidable interest for Brett Hull Company. Classification of a lease is provided.

$2.19
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Financial Accounting: capitalization of interest on PPE

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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