301696 Flashcards
Sea Manufacturing Corp. is constructing a new factory building. During the current calendar year, Sea made the following payments to the construction company:
January 2 $1,000,000
December 31 1,000,000
Sea has an 8%, three-year construction loan of $3,000,000. What is the amount of interest costs that Sea may capitalize during the current year?
$80,000
$240,000
$160,000
$0
$80,000
Interest expense is capitalized for assets that are constructed or otherwise produced for an enterprise’s own use. The amount of interest to be capitalized during a given accounting period is determined by applying the appropriate capitalization rate to the average amount of accumulated expenditures for the asset during that period. In general, the capitalization rate is a weighted average of the rates applicable to borrowings (debt) outstanding during the accounting period. Sea Manufacturing only had one borrowing, at a rate of 8%. Capitalized interest is computed as follows:
Average accumulated expenditures: $1,000,000 × 12/12 = $1,000,000
Capitalization rate 8%
Capitalized interest expense $ 80,000
Accounting Period
A basic assumption of accounting is that measurements are made and reports prepared for a specific time period, FASB Concepts Statement 8 indicates that useful financial information reports an entity’s resources and claims and their changes for a specific time period. For taxation, an accounting period is the time a taxpayer uses to determine income, deductions, and tax liability. The accounting period for a taxpayer is normally a calendar year (ends December 31), a fiscal year (ends the last day of any month except December), or a 52–53 week year (ends on the same day of the week each year).
IRC Sections 441 and 443
Assets
Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. They describe levels or amounts of resources at a moment in time.
SFAC 6.25–.34 and .172–.191
Essential characteristics, all three of which must be present, are as follows:
Embodies a probable future benefit that involves a capacity, singly or in combination with other assets, to contribute directly or indirectly to future net cash inflows
A particular entity can obtain the benefit and control others’ access to it.
The transaction or other event giving rise to the entity’s right to or control of the benefit has already occurred.
Economic benefits derive from the ability of assets to be exchanged for cash or other goods or services, by being used to produce goods or services to increase the value of other assets, or by being used to settle liabilities.
Services provided by other entities cannot be stored and are received and used simultaneously. Rights to receive services for specified or determinable future periods can be assets.
Assets are changed by transactions, activities, and events that happen to the entity, both those directly controlled by the entity (receipt and transfer of cash and other assets or adding value to noncash assets through operations by using, combining, and transforming goods into other goods) and those beyond its control (changes in prices, interest rates, and technology; impositions of taxes and regulations; discovery; growth or accretion; shrinkage; vandalism; theft; expropriations; and natural disasters).
“Valuation accounts” that increase or decrease the carrying value of assets are part of the related asset and are not assets, or liabilities, in their own right. These valuation accounts are either adjunct accounts (increase the related asset) or contra accounts (decrease the related asset).
In governmental accounting: Assets are defined as resources with present service capacity tha
Capitalization of Interest
Capitalization of interest is to record the cost of interest (as well as other time-related costs, such as taxes and insurance) paid to finance a long-term construction project (whether self-constructed or acquired from others and whether for self-use or for resale) as an asset and defer its recognition as an expense to future periods. It is not to exceed the total interest incurred during that period.
FASB ASC 835-20
Conceptually, the amount of interest to be capitalized is the interest that could have been avoided if the expenditures for the asset had not been made. It requires determination of average accumulated expenditures during each interim capitalization period and the capitalization rate (usually the purchaser’s incremental borrowing rate or a weighted-average interest rate).
Weighted Average
A weighted average is an average that takes into account the proportional relevance of each component, instead of treating each component equally. In accounting, some of the uses of a weighted average are in an inventory costing method, in determining the average shares outstanding during a particular period, and to determine the average of accumulated expenditures.
Example: The weighted average of the following costs for inventory items would be:
Unit Purchases Unit Cost Weight Unit Cost x Weight
100 $4.90 1 $ 4.90
200 $5.20 2 10.40
300 $5.50 3 16.50
6 $31.80
= ======
The weighted average of the units purchased = $31.80 ÷ 6 = $5.30.
2243.03
For qualifying assets, the interest cost incurred during the period of time required to carry out activities necessary to bring the asset to the condition and location necessary for its intended use is a part of the historical cost of acquiring the asset. The amount of interest to be capitalized during a given accounting period is determined by applying the appropriate capitalization rate to the average amount of accumulated expenditures for the asset during that period. Expenditures for this purpose are capitalized expenditures for the qualifying asset that have required the payment of cash, the transfer of other assets, or the incurring of a liability on which interest is recognized.
2243.04
In general, the capitalization rate shall be a weighted average of the rates applicable to borrowings (debt) outstanding during the accounting period for which the capitalizable interest is being calculated. However, if an enterprise associates a specific new borrowing with a qualifying asset, the enterprise may use the rate on that specific borrowing as the capitalization rate to be applied to that portion of the average accumulated expenditures for the asset that does not exceed the amount of the specific borrowing. If the average accumulated expenditures for the qualifying asset exceed the amount of that specific borrowing, the capitalization rate to be used on the excess is the weighted average of the rates applicable to other borrowings of the enterprise.
2243.05
The capitalization period normally begins when all of the following three conditions are present:
Expenditures for the asset have been made.
Activities that are necessary to get the asset ready for its intended use are in progress.
Interest cost is being incurred.
Interest capitalization shall continue as long as these conditions continue. The capitalization period ends when the qualifying asset is substantially complete and ready for its intended use.
2243.06
Since the capitalized interest becomes a part of the cost of the qualifying asset, its disposition should be the same as that of other components of the asset’s cost (e.g., depreciation, depletion, amortization, and cost of goods sold).
2243.07
In an accounting period in which no interest cost is capitalized, the total interest incurred and charged to expense during the period should be disclosed. In an accounting period in which some interest cost is capitalized, disclosure should be made of the total interest cost incurred, the amount capitalized, and the amount charged to expense.
2243.08
Example: In 20X1, Alpha Company decided to construct an additional warehouse to be used for storage of its raw materials. The following data, transactions, and events relate to this undertaking:
a. April 1, 20X1—Alpha borrowed $1 million on a 20% note maturing in 20X4 to help finance the following:
(1) The acquisition of land on which to build the warehouse
(2) The construction of the warehouse
Note: Alpha already has outstanding a 16%, $1 million note that was issued at face amount in 20X0 and matures in 20X5.
b. April 1, 20X1—Alpha purchased the land for the warehouse for $500,000. On this date, Alpha also contracted with Beta Company for construction of the warehouse. Beta began construction immediately, with completion scheduled for 20X2.
c. June 1, 20X1—Alpha paid Beta progress payments of $1.5 million.
d. April 1, 20X2—Alpha paid Beta progress payments of $1 million.
e. September 1, 20X2—Alpha paid Beta progress payments of $900,000.
f. December 31, 20X2—Alpha made the final payment to Beta in the amount of $600,000. The warehouse was accepted by Alpha on this date and is now ready for use.
FASB ASC 835-20-30-2 to 30-6
