Week1 Discussion

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National University College *

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401B

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Accounting

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Apr 3, 2024

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Week1: Codification Research Case Your client is in the planning phase for a major plant expansion, which will involve the construction of a new warehouse. The assistant controller does not believe interest costs can be included in the warehouse cost because it is a financing expense. Others on the planning team believe that some interest cost can be included in the warehouse cost, but no one could identify the specific authoritative guidance for this issue. Your supervisor asks you to research this issue. Provide Codification references for your answers.  Is it permissible to capitalize interest on the cost of assets? Provide authoritative support for your answer.  What are the objectives for capitalizing interest?  Discuss which assets qualify for interest capitalization.  Is there a limit to the amount of interest that may be capitalized in a period?  If interest capitalization is allowed, what disclosures are required? 1. Is it permissible to capitalize interest on the cost of assets? According to FASB 835-20-15-2: Interest cost is capitalizable for all assets that require a period to get them ready for their intended use (an acquisition period). However, in many cases, the benefit in terms of information about the entity's resources and earnings may not justify the additional accounting and administrative cost involved in providing the information. The significance of the effect of interest capitalization in relation to the entity's resources and earnings is the most important consideration in assessing its benefit. The ease with which qualifying assets and related expenditures can be separately identified and the number of assets subject to interest capitalization are important factors in assessing the cost of implementation. Furthermore, according to FASB codification 835-20-15-3, interest capitalization is mandated when the benefits outweigh implementation costs. This is more probable for assets constructed as discrete projects with substantial time, expenditure, and interest costs, rather than routine inventory production. Moreover, FASB codification 835-20- 15-4 discusses common minimum threshold levels in inventory and property, plant, and equipment accounting. Entities often exclude minor costs in inventory and assets below a specified threshold to ease accounting burdens, based on materiality considerations. 2. What are the objectives for capitalizing interest?

FASB codification 835-20-10-1 outlines the objectives of capitalizing interest, aiming to obtain a measure of acquisition cost closely reflecting an entity's total investment in the asset and to charge a cost related to acquiring a resource benefiting future periods against the revenues of the periods benefited. Consequently, capitalizing interest achieves accurate financial reporting and informed decision-making by aligning expenses with revenue generation, enhancing asset valuation, aiding in capital allocation decisions, and improving comparability and transparency across companies. This fosters trust among stakeholders and enables effective benchmarking. 3. Discuss which assets qualify for interest capitalization. FASB codification 835-20-15-5 specifies the types of assets (qualifying assets) for which interest shall be capitalized. These include: a. Assets that are constructed or otherwise produced for an entity's own use, including assets constructed or produced for the entity by others for which deposits or progress payments have been made. b. Assets intended for sale or lease that are constructed or otherwise produced as discrete projects (for example, ships or real estate developments). c. Investments (equity, loans, and advances) accounted for by the equity method while the investee has activities in progress necessary to commence its planned principal operations provided that the investee's activities include the use of funds to acquire qualifying assets for its operations. The investor's investment in the investee, not the individual assets or projects of the investee, is the qualifying asset for purposes of interest capitalization. 4. Is there a limit to the amount of interest that may be capitalized in a period? FASB codification 835-30-55-3 outlines the interest method, which generates regular interest earnings at a consistent effective rate on a loan. Moreover, in situations where interest collected upfront surpasses that calculated by the method, the surplus is deferred and acknowledged as income later. This ensures a steady yield, as seen in loans managed through

methods like sum-of-the-years-digits. Additionally, the amount of interest capitalized cannot exceed the total interest cost incurred during the capitalization period. In other words, any interest costs that exceed the capitalized amount must be recognized as an interest expense in the company's financial statements. 5. If interest capitalization is allowed, what disclosures are required? FASB codification 835-30-50-1 provides requirements for the balance sheet presentation for the discount or premium and debt issuance costs of a note. Additionally, the description of the note shall include the effective interest rate. Furthermore, the face amount of the note shall be presented in the financial statements or disclosed in the notes to financial statements. Moreover, GAAP requires companies to disclose the following information related to capitalized interest in their financial statements: a. The total amount of interest cost incurred during the reporting period. b. The amount of interest capitalized during the reporting period. c. A description of the qualifying assets for which interest was capitalized. d. The capitalization rate is used to determine the amount of capitalized interest. Should Hamilton follow his boss's directive? No, Hamilton should not follow his boss's directive. Increasing estimates for bad debt and warranty costs without justification would result in misleading financial reporting. Consequently, this could have several negative consequences. First, it would distort the true financial picture of the store, as overstating expenses would artificially lower profits, potentially impacting decisions by investors, lenders, or even Dotson themselves. Second, it would violate accounting principles. Generally Accepted Accounting Principles (GAAP) require estimates to be reasonable and based on historical data or expected outcomes. Inflating expenses without basis goes against these principles. Third, it would put Hamilton's professional ethics at risk. As an accountant, Hamilton has a responsibility to uphold ethical standards and maintain the integrity of financial records. Following Rich's directive could compromise his professional standing and potentially lead to legal repercussions.

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Who is harmed if the estimates are increased? If the estimates of bad debt expense and warranty costs are artificially inflated to decrease profits, multiple parties could experience adverse consequences: Firstly, shareholders: Shareholders rely on precise financial data to make well-informed investment decisions. Falsifying financial statements has the potential to mislead shareholders, jeopardizing their investments. Secondly, creditors: Creditors utilize financial statements to assess a company's financial stability and ability to repay debts. Misleading financial statements could harm creditors by presenting an inaccurate depiction of the company's financial status. Thirdly, Dotson company: In the event of discovering the misrepresentation later, they may lose trust in Rich Clothing Store and pursue legal action. Fourthly, tax authorities: Overstating expenses may result in tax underpayments, leading to penalties and fines. Moreover, employees: Employees could be negatively affected if the company's financial health is misrepresented, potentially resulting in layoffs or other adverse outcomes. Ultimately, inaccurate financial reporting can impede the store's ability to make informed decisions regarding future investments and operational strategies. Is Matt Rich's directive ethical? Matt Rich's directive to artificially inflate bad debt expense and warranty costs to maintain profits at a specific level is unethical. It is imperative for business leaders to uphold ethical standards and act with integrity in all business dealings. Falsifying financial statements is not only unethical but also illegal, as it contravenes accounting principles and regulations. Hamilton must resist directives to falsify financial statements and address the matter with Matt Rich, emphasizing the significance of honesty and integrity in financial reporting to maintain ethical standards.