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Intermediate Accounting: Reporting...
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Interest Capitalization
Gold Creek Company has borrowed large amounts of money to purchase 5,000 acres of land, which it will develop as a new ski area over the next 10 years. Development is currently under way on the first 2,000 acres, with trails being cut and ski lifts being built. When the company completes this initial development after 4 years, it will develop the remaining acreage at the rate of approximately 500 acres per year. The company also used some of the money it borrowed to purchase adjacent land, which it will use to expand the ski area if it is successful.
Because this is the first year of the company’s existence, it has not developed a policy about interest capitalization. Specifically, it is uncertain about whether it is entitled to capitalize interest on the amounts borrowed to acquire the first 2,000 acres, the total 5,000 acres, the 5,000 acres plus the adjacent land, or the land and the development.
Required:
- 1. Explain the interest capitalization that is appropriate under these circumstances.
- 2. How might the decision be influenced if the company were interested in earnings management?
1.
Explain the interest capitalization that is suitable under the circumstances provided.
- The first 2,000 acres qualify for capitalization of interest since the various provisions of GAAP are met. It meets the norms of a “qualifying asset” and the other three conditions for the beginning of the period of capitalization, expenditures made, progress of activities and the cost of interest is incurred.
- The 3,000 acres remaining of the initial 5,000 acres also meet the requirements for capitalization of interest. GAAP states that the term “activities “must be constructed largely and must comprise more than “physical construction”. Because, the 5,000 acres are purchased for a “single development”, activities are in improvement on the perfect 5,000 acres. It is less certain whether the adjacent parcel of land is suitable for capitalization of interest...
2.
Explain the way in which the decision could be influences if the company is interested in earnings management.
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