Initial Cost of Equipment
Central Machine Tools purchased industrial equipment to be used in its manufacturing process. The purchase price wa
Central paid a freight company $1,000 to transport the equipment to its plant location plus $300 shipping insurance.
In addition, the equipment had to be installed and mounted on a special platform built specifically for the equipment a
After installation, several trial runs were made to ensure proper operation. The cost of these trials including wasted ma
At what amount should Central capitalize the equipment?
Solution:
Purchase price ($ 62,000)
Freight and handling ( 1,000)
Insurance during shipping ( 300)
Special platform ( 1,200)
Trial runs ( 600)
Capitalized cost of equipment ($ 65,100)
Note:
Each of the expenditures described was necessary to bring the equipment to its condition and location for use and sho
These costs will be expensed in the future periods in which the equipment is used.
Initial Cost of Land
The Byers Structural Metal Company purchased a six-acre tract of land and an existing building for $500,000.
The company plans to remove the old building and construct a new office building on the site. In addition to the purcha
following expenditures at closing of the purchase:
Title insurance ($ 3,000)
Commissions ( 16,000)
Property taxes ( 6,000)
*The $6,000 in property taxes included $4,000 of delinquent taxes paid by Byers on behalf of the seller as well as $2,000
the current fiscal year that remains after the purchase date.
In addition, shortly after closing, Byers paid a contractor $10,000 to tear down the old building and remove it from the s
What should be the capitalized cost of the land?
Solution:
Purchase price of land (and old building) ($ 500,000)
Title insurance ( 3,000)
Commissions ( 16,000)
Delinquent property taxes ( 4,000)
Cost of removing old building ( 10,000)
Cost of grading ( 5,000)
Capitalized cost of land ($ 538,000)
Property taxes of $2,000 were not included. These relate only to the current operating period and should be expensed s
Other costs were necessary to acquire the land and are capitalized.
Lump-Sum Purchases
The Smyrna Hand & Edge Tools Company purchased an existing factory for a single sum of $2,000,000. The price in
the manufacturing equipment in the building, a patent on a process the equipment uses, and inventories of raw m
An independent appraisal estimated the fair values of the assets (if purchased separately) as follows:
Fair Values
Land ($ 330,000) 15%
Building ( 550,000) 25%
Equipment ( 660,000) 30%
Patent ( 440,000) 20%
Inventories ( 220,000) 10%
Total ($ 2,200,000) 100%
Solution:
Because the $2,200,000 fair value of the assets is greater than the $2,000,000 purchase price, the purchase price is
Land 15% X 2,000,000 ( 300,000)
Building 25% X 2,000,000 ( 500,000)
Equipment 30% X 2,000,000 ( 600,000)
Patent 20% X 2,000,000 ( 400,000)
Inventories 10% X 2,000,000 ( 200,000)
Cash ( 2,000,000)
Exchanges—Loss Situation
Information Processing, Inc. trades its used machine for a new model at Jerrod Business Solutions Inc. The exchange has
The used machine has a book value of $8,000 (original cost $12,000 less $4,000 accumulated depreciation) and a fair va
Jerrod gives Information Processing a trade-in allowance of $9,000 for the used machine.
How to compute the cost of the new asset?
How to compute Loss on Disposal of Used Machine?
Solution:
Price of new machine ($ 16,000)
Less: Trade-in allowance for used machine ( (9,000)
Cash payment due ( 7,000)
Fair value of used machine ( 6,000)
Cost of new machine ($ 13,000)
Information Processing records this transaction as follows.
Dr. New Equipment ( 13,000)
Dr. Accumulated Depreciation ( 4,000)
Dr. Loss on Disposal of Equipment ( 2,000)
Cr. Equipment ( 12,000)
Cr. Cash ( 7,000)
Computation of Loss on Disposal of Used Machine
Fair value of used machine ( 6,000)
Less: Book value of used machine ( (8,000)
Loss on disposal of used machine ($ (2,000)
Exchanges—Gain Situation
Interstate Transportation Company exchanged a number of used trucks plus cash for a semi-truck. The used trucks ha
$42,000 (cost $64,000 less $22,000 accumulated depreciation). Interstate’s purchasing agent, experienced in the seco
a fair value of $49,000. In addition to the trucks, Interstate must pay $11,000 cash for the semi-truck.
How to compute the cost of the semi-truck?
Solution:
Fair value of trucks exchanged ($ 49,000)
Cash paid ( 11,000)
Cost of semi-truck ($ 60,000)
Interstate records the exchange transaction as follows.
Dr. Trucks (Semi) ( 60,000)
Dr. Accumulated Depreciation ( 22,000)
Cr. Trucks (used) ( 64,000)
Cr. Gain on disposal ( 7,000) The gain is the difference betwee
Cr. Cash ( 11,000)
Computation of Gain on Disposal of Used Trucks
Fair value of used trucks ( 49,000)
Cost of used trucks ( 64,000)
Less: Accumulated depreciation ( 22,000)
Book value of used trucks ( (42,000)
Gain on disposal of used trucks ($ 7,000)
Lacks Commercial Substance—No Cash Received
We now assume that the Interstate Transportation Company exchange lacks commercial substance. That is, the econo
In this case, Interstate defers the gain of $7,000 and reduces the basis of the semi-truck.
Basis of Semi-Truck—Fair Value vs. Book Value
Fair value of semi-truck ( 60,000) OR Book value of used trucks
Less: Gain deferred ( 7,000) Plus: Cash paid
Basis of semi-truck ($ 67,000) Basis of semi-truck
Interstate records thIS transaction as follows.
Dr. Trucks (Semi) ( 53,000)
Dr. Accumulated Depreciation ( 22,000)
Cr. Trucks (used) ( 64,000)
Cr. Cash ( 11,000)
-truck. The used trucks have a combined book value of
t, experienced in the secondhand market, indicates that the used trucks have
is the difference between the fair value of the used trucks and their book value.
bstance. That is, the economic position of Interstate did not change significantly as a result of this exchange.
( 42,000)
( 11,000)
($ 53,000)
Comprehensive Example of Interest Capitalization
on November 1, 2019, Shalla Company contracted Pfeifer Construction Co. to construct a building for $1,400,000 on lan
included in the first payment). Shalla made the following payments to the construction company during 2020.
1-Jan 1-Mar 1-May 31-Dec Total
( 210,000) ( 300,000) ( 540,000) ( 450,000) ( 1,500,000)
Pfeifer Construction completed the building, ready for occupancy, on December 31, 2020. Shalla had the following debt o
Specific Construction Debt
1. 15%, 3-year note to finance purchase of land and construction of the building, dated December 31, 2019, with intere
Other Debt
2. 10%, 5-year note payable, dated December 31, 2016, with interest payable annually on December 31 $550,000
a. Computation of Weighted- Average Accumulated Expenditures
b. Computation of Avoidable (Capitalized) Interest
c. Computation of Actual Interest Cost
Solution:
a Computation of Weighted- Average Accumulated Expenditures
Expenditures Capitalization Weighted-average
Date Amount x Period = Accumulated Expenditures
1-Jan ( 210,000) 12/12 ($ 210,000)
1-Mar ( 300,000) 10/12 ( 250,000)
1-May ( 540,000) 8/12 ( 360,000)
31-Dec ( 450,000) 0 ( - )
( 1,500,000) ($ 820,000)
b Computation of Avoidable (Capitalized) Interest
Weighted-average
Accumulated Expenditures Interest rate = Capitalized Interest ** The amount by whic
( 750,000) x ( 0.15) ( 112,500) expenditures exceeds t
** ( 70,000) x ( 0.10) ( 7,000)
( 820,000) ( 119,500)
c Computation of Actual Interest Cost
Construction note 750,000 x .15 = ($ 112,500)
5-year note 1,150,000 x .10 ( 115,000)
Actual interest ($ 227,500)
Shalla records the following journal entries during 2020.
1-Jan Land ( 100,000)
Buildings (or Construction in Process) ( 110,000)
ng for $1,400,000 on land costing $100,000 (purchased from the contractor and
y during 2020.
a had the following debt outstanding at December 31, 2020.
ber 31, 2019, with interest payable annually on December 31 ($ 750,000.00)
ember 31 $550,000 ($1,150,000.00)
Note that the expenditure made on December 31,
the last day of the year, does not have any interest cost.
5-year note is being utilized
** The amount by which the weighted-average accumulated
expenditures exceeds the specific construction loan.
Statement of comprehensive income, Shalla
Income from operations XXXX
Other expenses and losses:
Cash ( 210,000)
1-Mar Buildings ( 300,000)
Cash ( 300,000)
1-May Buildings ( 540,000)
Cash ( 540,000)
31-Dec Buildings ( 450,000)
Buildings (Capitalized
Cash Interest) ( 119,500)
Interest Expense ( 108,000)
Cash ( 677,500)
Interest expense ($ 227,500)
Less: Capitalized interest ( 119,500) ( 108,000)
Income before income taxes XXXX
Income taxes XXX
Net income XXXX
