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Flashcards: Capitalizing Property, Plant, and Equipment

On January 2, Year 1, a company borrows $1.2 million on a note due in 10 years. Each year interest of 9% of the principal must be paid. Proceeds from the loan are used to finance the construction of a building. All proceeds are spent evenly throughout the year and the building is complete at the end of Year 1. At what amount is the building capitalized?

$1,254,000

$1,200,000

$1,218,000

$1,308,000

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Flashcards: Capitalizing Property, Plant, and Equipment

Your answer:

$1,200,000

Your answer:

$1,218,000

Your answer:

$1,308,000

Correct answer:

$1,254,000

Explanation:

The capitalized cost of the building will include the principled borrowed as well as the average interest cost for the year. Total interest paid for the year is equal to $1.2M x 9% = $108K. Because the funds were spent evenly throughout the year, interest is averaged to best capture the cost of the building ($0 interest at the start of the year + $108K interest at the end of the year divided by 2 = $54K.) Therefore, the total capitalized cost is equal to $1.2M + $54K.

Flashcards: Capitalizing Property, Plant, and Equipment

On January 1, Year 1, the Morgan Corporation borrowed $3 million at an interest rate of 8% per year. The company immediately began construction on a warehouse using the borrowed money. Work was performed evenly throughout the year and the warehouse was completed at the end of Year 1 at a total cost of $2.5 million. What amount of interest should Morgan recognize as interest expense in Year 1?

$240,000

$200,000

$140,000

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Flashcards: Capitalizing Property, Plant, and Equipment

Your answer:

$240,000

Your answer:

$200,000

Your answer:

Correct answer:

$140,000

Explanation:

All of the interest on the portion of the loan not used for construction will be expensed in the current year ($500K x 8%). In addition, the portion of interest on the construction funds that is not capitalized should also be expensed. This is calculated by taking the average interest paid (because costs were incurred evenly throughout the year) and expensing the uncapitalized portion. Average interest is equal to $100K ($2.5M x 8% divided by 2). Therefore, total interest expense is $40K + $100K.

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All CPA Financial Accounting and Reporting (FAR) Resources

Flashcards: Capitalizing Property, Plant, and Equipment

Flashcards: Capitalizing Property, Plant, and Equipment

Flashcards: Capitalizing Property, Plant, and Equipment

Flashcards: Capitalizing Property, Plant, and Equipment

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