P 10-12 acquisition costs; lump-sum acquisition; noninterest-bearing

P 10-12 Acquisition costs; lump-sum acquisition; noninterest-bearing note; interest capitalization


P 10-12  Early in its fiscal year ending December 31, 2011, 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 $800,000. San Antonio paid $200,000 and signed a noninterest-bearing note requiring the company to pay the remaining $600,000 on March 28, 2013. An interest rate of 8% properly reflects the time value of money for this type of loan agreement. Title search, insurance, and other closing costs totaling $20,000 were paid at closing.


During April, the old building was demolished at a cost of $70,000, and an additional $50,000 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:


May 30             $1,200,000

July 30             1,500,000

September 1     900,000

October 1         1,800,000


San Antonio borrowed $3,000,000 at 8% on May 1 to help finance construction. This loan, plus interest, will be paid in 2012. The company also had the following debt outstanding throughout 2011:


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

$4,000,000, 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 $600,000. The fair values of the equipment and the furniture and fixtures were $455,000 and $245,000, respectively. In December, San Antonio paid a contractor $285,000 for the construction of parking lots and for landscaping.



1. Determine the initial values of the various assets that San Antonio acquired or constructed during 2011. 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 2011 income statement?


Problem 10-12

Requirement 1


            Purchase price (determined below)                   $714,404

            Closing costs                                                          20,000

            Removal of old building                                      70,000

            Clearing and grading                                           50,000


            Purchase price of land:

                 Cash paid                                                      $200,000

                 Value of note                                                514,404


            Present value of note payment:

            PV = $600,000 (.85734)  = $514,404

          Present value of $1: n = 2, i = 8% (from Table 2)


            Land improvements

            Parking lot and landscaping                          $285,000


          Construction expenditures:

                   May 30                                      $1,200,000

                   July 30                                         1,500,000

                   September 1                                    900,000

                   October 1                                     1,800,000

                      Total expenditures                     5,400,000

          Interest capitalized (determined below)               94,000

               Total cost of building                      $5,494,000






            Average accumulated expenditures:

            May 31, 2011                $1,200,000  x   5/6  =    $ 1,000,000

            July 30, 2011                   1,500,000  x   3/6  =           750,000

            September 1, 2011           900,000  x   2/6  =           300,000    

            October 1, 2011             1,800,000  x   1/6  =           300,000



            Interest capitalized:

            $2,350,000 x 8% x 6/12 =                                             $94,000

Equipment and furniture and fixtures


                                                                             Percent of Total             Valuation

                                               Fair Value                 Fair Value                % x $600,000

Equipment                            $455,000                        65%                       $390,000

Furniture & fixtures              245,000                       35%                          210,000

            Totals                         $700,000                     100%                       $600,000



Initial valuation:

Equipment                           $390,000

Furniture & fixtures             210,000

Requirement 2


Interest expense:

      Note issued to purchase land and building,

          $514,404 x 8% x 9/12 =                                                $  30,864

      Construction loan, $3,000,000 x 8% x 8/12                  160,000

      Long-term note, $2,000,000 x 9%                                   180,000

      Long-term bonds, $4,000,000 x 6%                                240,000

           Total                                                                                   610,864

      Less: Interest capitalized (determined above)             (94,000)

Interest expense                                                                      $516,864



 Assignment: Create a General Journal from the information above

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