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Chapter 10: Q4BE (page 532)

Use the information for Hanson Company from BE10-2 and BE10-3. Compute avoidable interest for Hanson Company.

Hanson Company is constructing a building. Construction began on February 1 and was completed on December 31. Expenditures were \(1,800,000 on March 1, \)1,200,000 on June 1, and \(3,000,000 on December 31.

Hanson Company borrowed \)1,000,000 on March 1 on a 5-year, 12% note to help finance construction of the building. In addition, the company had outstanding all year a 10%, 5-year, \(2,000,000 note payable and an 11%, 4-year, \)3,500,000 note payable

Short Answer

Expert verified

Avoidable Interest: $247,680

Step by step solution

01

Meaning of Avoidable Interest.

Theamount of interest saved in the absence of the projectis known as avoidable interest.The weighted average interest is then multiplied by the interest rate to find the avoidable interest.

02

Computing Avoidable Interest.

Weighted-Average Interest

Interest Rate

Avoidable Interest

$1,000,000 12%

$120,000

1,200,000 10.64%

127,680

$2,200,000

$247,680

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Most popular questions from this chapter

(Analysis of Subsequent Expenditures) Plant assets often require expenditures subsequent to acquisition. It is important that they be accounted for properly. Any errors will affect both the balance sheets and income statements for a number of years.

Instructions

For each of the following items, indicate whether the expenditure should be capitalized (C) or expensed (E) in the period incurred.

  1. __________ Improvement.
  2. __________ Replacement of a minor broken part on a machine.
  3. __________ Expenditure that increases the useful life of an existing asset.
  4. __________ Expenditure that increases the efficiency and effectiveness of a productive asset but does not increase its salvage value.
  5. __________ Expenditure that increases the efficiency and effectiveness of a productive asset and increases the asset’s salvage value.
  6. __________ Expenditure that increases the quality of the output of the productive asset.
  7. __________ Improvement to a machine that increased its fair market value and its production capacity by 30% without extending the machine’s useful life.
  8. __________ Ordinary repairs.

Question: Two positions have normally been taken with respect to the recording of fixed manufacturing overhead as an element of the cost of plant assets constructed by a company for its own use: (a) It should be excluded completely. (b) It should be included at the same rate as is charged to normal operations.

What are the circumstances or rationale that support or deny the application of these methods?

(Asset Acquisition) Hayes Industries purchased the following assets and constructed a building as well. All this was done during the current year.

Assets 1 and 2: These assets were purchased as a lump sum for \(100,000 cash. The following information was gathered.

Description

Initial Cost on Seller’s Books

Depreciation to Date on Seller’s Books

Book Value on Seller’s Books

Appraised value

Machinery

\)100,000

\(50,000

\)50,000

\(90,000

Equipment

60,000

10,000

50,000

30,000

Asset 3: This machine was acquired by making a \)10,000 down payment and issuing a \(30,000, 2-year, zero-interest-bearing note. The note is to be paid off in two \)15,000 installments made at the end of the first and second years. It was estimated that the asset could have been purchased outright for \(35,900.

Asset 4: This machinery was acquired by trading in used machinery. (The exchange lacks commercial substance.) Facts concerning the trade-in are as follows.

Cost of machinery traded

\)100,000

Accumulated depreciation to date of sale

40,000

Fair value of machinery traded

80,000

Cash received

10,000

Fair value of machinery acquired

70,000

Asset 5: Equipment was acquired by issuing 100 shares of \(8 par value common stock. The stock had a market price of \)11 per share.

Construction of Building: A building was constructed on land purchased last year at a cost of \(150,000. Construction began on February 1 and was completed on November 1. The payments to the contractor were as follows.

Date

Payment

2/1

\)120,000

6/1

360,000

9/1

480,000

11/1

100,000

To finance construction of the building, a \(600,000, 12% construction loan was taken out on February 1. The loan was repaid on November 1. The firm had \)200,000 of other outstanding debt during the year at a borrowing rate of 8%.

Instructions

Record the acquisition of each of these assets.

(Acquisition Costs of Trucks) Kelly Clarkson Corporation operates a retail computer store. To improve delivery services to customers, the company purchases four new trucks on April 1, 2017. The terms of acquisition for each truck are described below.

  1. Truck #1 has a list price of \(15,000 and is acquired for a cash payment of \)13,900.
  2. Truck #2 has a list price of \(16,000 and is acquired for a down payment of \)2,000 cash and a zero-interest-bearing note with a face amount of \(14,000. The note is due April 1, 2018. Clarkson would normally have to pay interest at a rate of 10% for such a borrowing, and the dealership has an incremental borrowing rate of 8%.
  3. Truck #3 has a list price of \)16,000. It is acquired in exchange for a computer system that Clarkson carries in inventory. The computer system cost \(12,000 and is normally sold by Clarkson for \)15,200. Clarkson uses a perpetual inventory system.
  4. Truck #4 has a list price of \(14,000. It is acquired in exchange for 1,000 shares of common stock in Clarkson Corporation. The stock has a par value per share of \)10 and a market price of $13 per share.

Instructions

Prepare the appropriate journal entries for the above transactions for Clarkson Corporation.

(Capitalization of Interest) The following three situations involve the capitalization of interest

Situation I: On January 1, 2017, Oksana Baiul, Inc. signed a fixed-price contract to have Builder Associates construct a major plant facility at a cost of \(4,000,000. It was estimated that it would take 3 years to complete the project. Also on January 1, 2017, to finance the construction cost, Oksana Baiul borrowed \)4,000,000 payable in 10 annual installments of \(400,000, plus interest at the rate of 10%. During 2017, Oksana Baiul made deposit and progress payments totaling \)1,500,000 under the contract; the weighted average amount of accumulated expenditures was \(800,000 for the year. The excess borrowed funds were invested in short-term securities, from which Oksana Baiul realized investment income of \)250,000.

Instructions

What amount should Oksana Baiul report as capitalized interest at December 31, 2017?

Situation II: During 2017, Midori Ito Corporation constructed and manufactured certain assets and incurred the following interest costs in connection with those activities.

Interest Costs Incurred

Warehouse constructed for Ito’s own use

\(30,000

Special-order machine for sale to unrelated customer, produced according to customer’s specifications

9,000

Inventories routinely manufactured, produced on a repetitive basis

8,000

All of these assets required an extended period of time for completion.

Instructions

Assuming the effect of interest capitalization is material, what is the total amount of interest costs to be capitalized?

Situation III: Peggy Fleming, Inc. has a fiscal year ending April 30. On May 1, 2017, Peggy Fleming borrowed \)10,000,000 at 11% to finance construction of its own building. Repayments of the loan are to commence the month following completion of the building. During the year ended April 30, 2018, expenditures for the partially completed structure totaled \(7,000,000. These expenditures were incurred evenly throughout the year. Interest earned on the unexpended portion of the loan amounted to \)650,000 for the year.

Instructions

How much should be shown as capitalized interest on Peggy Fleming’s financial statements on April 30, 2018?
See all solutions

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