Question

January 1, Year 1, Cougar Corporation exchanged machinery for a six-acre tract of land with Ellis Corporation. The machinery has a book value of $2 million and a fair value of $2.2 million. Cougar also wrote a $500,000 non-interest bearing one year note payable on December 31, Year 1, to Ellis Corporation to make the transaction go through. Assume the exchange has commercial substance . Also assume similar loans bear a 12% interest. (For one year, FV of $1 at 12% = 1.12; PV of $1 at 12% =0.89) Cougar built a warehouse on this tract of land during years 2 and 3. The following payments were made during construction for building materials, labor, and overhead:

January 1, Year 2 = $130,000 April 1, Year 2 = $240,000 October 1,Year 2 = $200,000 February 1, Year 3 = $350,000

In addition, Cougar:

- Borrowed $300,000 at 12% on January 1, Year 2, under a construction note

-Had bonds outstanding of $100,000 at 10%, on January 1, Year 2; interest is paid annually on December 31

-Had notes payable outstanding of $300,000 at 7% on January 1, Year 2; interest is payable annually on December 31

-Completed construction on the building, which was ready for immediate use on March 1, Year 3

Please calculate the cost of the warehouse:

Answer 1

Calculation of cost of the warehouse-

In this there are mainly 2 components, purchase of land and then construction of warehouse.

Cost to purchase Land and cost to construct warehouse is mentioned below with necessary explanations-

Cost of Land-

Details	Amount	Calculation	Explanation
Fair value of exchanged Machinery	2,200,000		Machinery is exchanged to purchase Land, so Land cost should include machinery at fair value (as coughar corp would have received 2.2mn if sold to outsider)
Notes Payable	445,000	500000*0.89	As 500k is paid at the end of year one, it is discounted to arrive at present value (PV of $1 at 12% - 0.89)
Cost of Land	2,645,000

Cost to Construct warehouse-

Details	Amount	Calculation	Explanation
Materials, Labor, Overheads - Payments made on
January 1, Year 2	130,000		All the material, Labor and overhead paid should be added to the cost of warehouse
April 1, Year 2	240,000
October 1,Year 2	200,000
February 1, Year 3	350,000
Interest on Amount borrowed-
Construction Note	12,000	300000*12%*14/12	Warehouse was completed on March 1 Year 3, so till that time all interest accrued should be added to the cost of warehouse. No. of months - 12+2 = 14 months interest to be capitalized
Bonds Outstanding	11,667	100000*10%*14/12
Notes Payable Outstanding	24,500	300000*7%*14/12
Cost to construct Warehouse	968,167

Total cost of Warehouse would be - Cost of Land + Cost to construct warehouse

= 2,645,000 + 968,167

= 3,613,167

Hence, cost of warehouse for Cougar corporation would be 3,613,167