Early in its fiscal year ending December 31 2018 San Antonio

Early in its fiscal year ending December 31, 2018, San Antonio Outfitters finalized plans to expand operations. The first stage was completed on January 1 with the purchase of a tract of land on the outskirts of the city. The land and existing building were purchased for $880,000. San Antonio paid $240,000 and signed a noninterest bearing note requiring the company to pay the remaining $640,000 on January 1, 2020. An interest rate of 10% properly reflects the time value of money for this type of loan agreement. Title search, insurance, and other closing costs totaling $24,000 were paid at closing.

During January, the old building was demolished at a cost of $74,000, and an additional $54,000 was paid to clear and grade the land. Construction of a new building began on February 1 and was completed on December 1. Construction expenditures were as follows:

February 1 $ 1,800,000

April 30 2,400,000

July 1 800,000

November 1 1,200,000

San Antonio borrowed $4,500,000 at 9% on February 1 to help finance construction. This loan, plus interest, will be paid in 2019. The company also had the following debt outstanding throughout 2018:

$2,500,000, 10% long-term note payable

$5,500,000, 7% 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 $640,000. The fair values of the equipment and the furniture and fixtures were $555,000 and $185,000, respectively. In December, San Antonio paid a contractor $305,000 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?

Solution

1. Land:

Present value of note payable = 640000 x 0.826 = 528,640

Add: Cash Paid = 240,000

Purchase Price of land = 768,640

Add: Closing costs = 24,000

Removal of old building = 74,000

Clearing and grading = 54,000

Total cost of land = 920,640

Land Improvements:

Parking lots and Landscaping = 305,000

Building:

Construction Expenditures;

February 1 = 1,800,000

April 30 = 2,400,000

July 1 = 1,800,000

November 1 = 1,200,000

Total expenditures = 7,200,000

Capitalized interest = 157,500

Total cost of Building = 7,357,500

Accumulated Expenditures;

February 1 (1,800,000 x 5/10) = 900,000

April 30 (2,400,000 x 3/10) = 720,000

July 1 ( 1,800,000 x 2/10) = 360,000

November 1 (1,200,000 x 1/10) = 120,000

Total = 2,100,000

Interest Capitalized (2,100,000 x 9% x 10/12) = 157,500

Equipment:

Fair Value = 555,000

Percent of total fair value [555,000 / (555,000+185,000)] = 75%

Initial value (640,000 x 75%) = 480,000

Furniture and Fixtures Fair Value = 185,000

Percent of total fair value [185,000/ (555,000+185,000) = 25%

Initial value (640,000 x 25%) = 160,000

2. Interest expense to be reported

Notes issued to purchase land and building (768,640 x 9% x 9/12) = 51,883

Construction loan (4,500,000 x 9% x 11/12) = 371,250

Long-term note ( 2,500,000 x 10%) = 250,000

Long-term bonds (5,500,000 x 7%) = 385,000

Total = 1,058,133

Less; Interest capitalized = (157,500)

Interest Expense = 900,633