Question

Problem 10-12 Acquisition costs; lump-sum acquisition; noninterest-bearing note; interest capitalization [LO10-1, 10-2, 10-3, 10-7]

Early in its fiscal year ending December 31, 2018, San Antonio Outfitters finalized plans to expand operations. The first stage was completed on March 28 with the purchase of a tract of land on the outskirts of the city. The land and existing building were purchased for $860,000. San Antonio paid $230,000 and signed a noninterest-bearing note requiring the company to pay the remaining $630,000 on March 28, 2020. An interest rate of 6% properly reflects the time value of money for this type of loan agreement. Title search, insurance, and other closing costs totaling $23,000 were paid at closing.

During April, the old building was demolished at a cost of $73,000, and an additional $53,000 was paid to clear and grade the land. Construction of a new building began on May 1 and was completed on October 29. Construction expenditures were as follows: (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) May 1 $ 1,650,000 July 30 1,650,000 September 1 1,080,000 October 1 1,980,000

San Antonio borrowed $3,400,000 at 6% on May 1 to help finance construction. This loan, plus interest, will be paid in 2019. The company also had the following debt outstanding throughout 2018:

$2,300,000, 9% long-term note payable

$4,300,000, 6% long-term bonds payable

In November, the company purchased 10 identical pieces of equipment and office furniture and fixtures for a lump-sum price of $630,000. The fair values of the equipment and the furniture and fixtures were $511,000 and $219,000, respectively. In December, San Antonio paid a contractor $300,000 for the construction of parking lots and for landscaping. Required:

1. Determine the initial values of the various assets that San Antonio acquired or constructed during 2018. The company uses the specific interest method to determine the amount of interest capitalized on the building construction.

2. How much interest expense will San Antonio report in its 2018 income statement?

1.

	Assets Initial Value Land Land improvements Building Equipment Furniture & fixtures

2.

Interest Expense

?????

Answer 1

Requirement 1

            Land

            Purchase price (determined below)                   $790,694

            Closing costs                                                          23,000

            Removal of old building                                      73,000

            Clearing and grading                                           53,000

                                                                                          $939,694

            Purchase price of land:

                 Cash paid                                                      $230,000

                 Value of note^†                                                560,694

                                                                                          $790,694

            ^† Present value of note payment:

            PV = $630,000 (.88999) = $560,694

          Present value of $1: n = 2, i = 6% (from Table 2)

            Land improvements

            Parking lot and landscaping                          $300,000

            Building

          Construction expenditures:

                   May 1                                      $1,650,000

                   July 30                                         1,650,000

                   September 1                                1,080,000

                   October 1                                     1,980,000

                      Total expenditures                     6,360,000

          Interest capitalized (determined below)               86,700

               Total cost of building                      $6,446,700

            Average accumulated expenditures:

            May 31, 2011                $1,650,000 x   5/6 =    $ 1,375,000

            July 30, 2011                   1,650,000 x   3/6 =           825,000

            September 1, 2011           1080,000 x   2/6 =           360,000    

            October 1, 2011            1,980,000 x   1/6 =           330,000

                                                                                                  $2,890,000

            Interest capitalized:

            $2,890,000 x 6% x 6/12 =                                             $86,700

Equipment and furniture and fixtures

Initial

Percent of Total             Valuation

Fair Value                 Fair Value                % x $630,000

Equipment                            $511,000                        70%                       $441,000

Furniture & fixtures              219,000                       30%                          189,000

Totals                         $730,000                     100%                       $630,000

Initial valuation:

Equipment                           $441,000

Furniture & fixtures             189,000

Requirement 2

Interest expense:

      Note issued to purchase land and building,

          $560,694 x 6% x 9/12 =                                                $ 25,231

      Construction loan, $3,400,000 x 6% x 8/12                  136,000

      Long-term note, $2,300,000 x 9%                                   207,000

      Long-term bonds, $4,300,000 x 6%                                258,000

           Total                                                                                   626,231

      Less: Interest capitalized (determined above)             (86,700)

Interest expense                                                                      $539,531