Chapter 10, Problem 10.12P

1.

To determine

Acquisition Cost:

Acquisition cost is the total cost of the asset incurred to obtain an asset. Acquisition cost is also called as historical cost or original cost.

Interest Capitalization:

Interest capitalization refers to the interest amount that is added to the cost of the long-term asset. Such interest capitalization amount includes the interest amount of the debt which was financed for acquiring the asset.

To Determine: The initial value of the various assets that were acquired or constructed during the year 2016 by S outfitters.

Explanation of Solution

Determine the initial value of the various assets that were acquired or constructed during the year 2016 by S outfitters.

Determine the initial value of land.

Particulars	Amount ($)
Purchase price	714,404
Add: Closing costs	20,000
Add: Removal of old building	70,000
Add: Clearing and grading	50,000
Total value of  land	854,404

Table (1)

Working Notes:

Determine the present value of note that was used to purchase the land.

$\begin{array}{c}\text{Present value = Present value annuity }\times \text{Present value of \$1 }\\ =\text{\$600,000 }\times \text{.85734}\\ =\text{\$514,404}\end{array}$ (1)

Note: PV factor (Present value of $1: n = 2, i = 8%) is taken from the table value (Table 2 in Appendix from textbook).

Determine the purchase price of land.

$\begin{array}{c}\text{Purchase price = Cash paid + Value of note }\\ =\$200,000+\$514,404\left(1\right)\\ =\$714,404\end{array}$

Thus, the initial value of land is $854,404.

Determine the initial value of land improvements.

Particulars	Amount ($)
Parking lot and landscaping	285,000

Table (2)

Thus, the initial value of land improvements is $285,000.

Determine the initial value of building.

Determine the amount of interest capitalized.

Month	Construction Expenditure ($)		Interest Outstanding (Number of months)		Accumulated Expenditure ($)
May 1	1,200,000	$\times$	$\frac{6}{6}$	=	1,200,000
July 30	1,500,000	$\times$	$\frac{3}{6}$	=	750,000
September 1	900,000	$\times$	$\frac{2}{6}$	=	300,000
October 1	1,800,000	$\times$	$\frac{1}{6}$	=	300,000
Average accumulated expenditures					$2,550,000

Table (3)

$\begin{array}{c}\text{Therefore, capitalized}\text{interest = }\left(\begin{array}{l}\text{Average Accumulated Expenditure }\\ \times \text{ Interest rate }\times \frac{\text{Number of months in a year}}{12}\end{array}\right)\\ =\$2,550,000\times \frac{8}{100}\times \frac{6}{12}\\ =\$102,000\end{array}$

Determine the initial value of building.

Particulars	Amount ($)
Construction expenditure
May 1, 2016	1,200,000
July 30, 2016	1,500,000
September 1, 2016	900,000
October 1, 2016	1,800,000
Total expenditures	5,400,000
Add: Interest capitalized	102,000
Total cost of building	5,502,000

Table (4)

Thus, the initial value of buildings is $5,502,000.

Determine the initial value of equipment and furniture and fixtures.

Determine the initial value of Equipment.

$\begin{array}{c}\text{Initial value of equipment =Percentage of total fair value}\times \text{Lump - sum price }\\ \text{= \$65\%}\times \text{ \$600,000}\\ \text{=\$390,000}\end{array}$

Thus, the initial value of equipment is $390,000.

Working Note:

$\begin{array}{c}\text{Percentage of total fair value = }\frac{\text{ Fair value }}{\text{Total}\text{value}}\times 100\\ =\frac{\$455,000}{\$700,000}\times 100\\ =65\%\end{array}$

Determine the initial value of Furniture and fixtures. 

$\begin{array}{c}\text{Initial value of furniture =Percentage of total fair value}\times \text{Lump - sum price }\\ \text{= \$35\%}\times \text{ \$600,000}\\ \text{=\$210,000}\end{array}$

Working Note:

$\begin{array}{c}\text{Percentage of total fair value = }\frac{\text{ Fair value }}{\text{Total}\text{value}}\times 100\\ =\frac{\$245,000}{\$700,000}\times 100\\ =35\%\end{array}$

Thus, the initial value of furniture and fixtures is$210,000.

2.

To determine

The interest expense reported in the 2016 income statement of S Outfitters.

Explanation of Solution

Determine the interest expense reported in the 2016 income statement of S Outfitters.

Particulars	Amount ($)
Note issued to purchase land and building	30,864
Construction loan	160,000
Long-term note	180,000
Long-term bonds	240,000
Total	610,864
Less: Interest capitalized	(102,000)
Interest expense	508,864

Table (5)

Working Notes:

Calculate the interest of construction loan.

$\begin{array}{c}\text{Interest = }\left(\begin{array}{l}\text{Loan amount }\\ \times \text{ Interest rate }\times \frac{\text{Number of months in a year}}{12}\end{array}\right)\\ =\$3,000,000\times \frac{8}{100}\times \frac{8}{12}\\ =\$160,000\end{array}$

Calculate the interest of the note.

$\begin{array}{c}\text{Interest = }\left(\begin{array}{l}\text{Value of note }\\ \times \text{ Interest rate }\times \frac{\text{Number of months in a year}}{12}\end{array}\right)\\ =\$514,404\times \frac{8}{100}\times \frac{9}{12}\\ =\$30,864\end{array}$

Calculate the interest of the long-term note.

$\begin{array}{c}\text{Interest = }\left(\text{Value of note }\times \text{ Interest rate }\right)\\ =\$2,000,000\times \frac{9}{100}\\ =\$180,000\end{array}$

Calculate the interest of the long-term bonds.

$\begin{array}{c}\text{Interest = }\left(\text{Value of note }\times \text{ Interest rate }\right)\\ =\$4,000,000\times \frac{6}{100}\\ =\$240,000\end{array}$

Conclusion

Thus, the amount of interest expense reported in the 2016 income statement is $508,864