Chapter 10, Problem 9P

1.

To determine

Journalize entries to record all construction costs for each of the 3 years.

Explanation of Solution

Property, Plant, and Equipment:

Property, Plant, and Equipment refers to the fixed assets, having a useful life of more than a year that is acquired by a company to be used in its business activities, for generating revenue.

Capitalized interest:

Interest Cost incurred to finance the construction of a long-term construction projects are known as capitalized interest.

Prepare Journal entries, 2016, 2017, 2018:

Date	Account titles and explanation	Debit ($)	Credit ($)
2016	Construction in Progress	6,000,000
	Cash		6,000,000
	(To record the construction in progress)
2016	Cash (10)	770,000
	Interest Revenue		770,000
	(To record the interest revenue)
2016	Interest Expense (11)	7,730,000
	Construction in Progress (1)	270,000
	Cash (14)		8,000,000
	(To record interest expense)
2017	Construction in Progress	11,460,000
	Cash		11,460,000
	(To record the construction in progress)
2017	Interest Expense (12)	6,630,000
	Construction in Progress (3)	1,370,000
	Cash		8,000,000
	(To record interest expense)
2018	Construction in Progress	1,800,000
	Cash		1,800,000
	(To record the construction in progress)
2018	Interest Expense (13)	7,487,500
	Construction in Progress (7)	512,500
	Cash		8,000,000
	(To record the interest expense)
2018	Building (15)	21,412,500
	Construction in Progress		21,412,500
	(To record construction in progress)

 (Table 1)

Note: The amount of capitalized interest is transferred to construction in progress account during the respective years.

Working notes:

(1)Calculate the amount of capitalized interest for the year 2016:

$\begin{array}{c}\begin{array}{l}\text{Construction}\\ \text{in}\text{progress}\end{array}\}\text{=}\left(\text{Average}\text{costs}\text{×}\text{percentage}\text{of}\text{interests}\text{×}\text{Time}\text{period}\right)\\ \text{=\$}\text{3,000,000}\text{(2)×12\%×}\frac{\text{9}}{\text{12}}\\ \text{=\$270,000}\end{array}$

Note: Interest is capitalized only for 9 months since; the activities are suspended for 3 months.

(2)Calculate the amount of average costs for the year 2016:

$\begin{array}{c}\text{Average}\text{costs}\text{=}\frac{\left(\text{Beginning}\text{cumulative}\text{costs}\text{+}\text{Ending}\text{cumulative}\text{costs}\right)}{\text{2}}\\ \text{=}\frac{\left(\text{\$0+\$6,000,000}\right)}{\text{2}}\\ \text{=\$3,000,000}\end{array}$

(3)Calculate the amount of capitalized interest for the year 2017:

$\begin{array}{c}\text{Capitalized}\text{interest}\text{=}\left[\begin{array}{l}\left(\text{Amount}\text{borrowed}\text{during}\text{2016}\text{×}\text{Interest}\text{rate}\right)\text{+}\\ \left(\text{Additional}\text{Amount}\text{to}\text{be}\text{capitalized}\text{during}\text{2017}\text{×}\text{Interest}\text{rate}\right)\end{array}\right]\\ \text{=}\left[\left(\text{\$10,000,000}\text{×}\text{12\%}\right)\text{+}\left(\text{\$2,000,000}\text{(4)}\text{×}\text{8}\text{.5\% }(6)\right)\right]\\ \text{=}\text{\$1,370,000}\end{array}$

(4)Calculate the additional amount to be capitalized during 2017:

$\begin{array}{c}\begin{array}{l}\text{Additional amount to}\\ \text{ be capitalized during 2017}\end{array}\}\text{=}\left(\begin{array}{l}\text{Average}\text{costs}\text{during}\text{the}\text{year}\text{2017}-\\ \text{Amount}\text{borrowed}\text{during}\text{2016}\end{array}\right)\\ \text{=}\text{\$12,000,000}\text{(5)}-\text{\$10,000,000}\\ \text{=\$2,000,000}\end{array}$

(5)Calculate the average costs during the year 2017:

$\begin{array}{c}\begin{array}{l}\text{Average costs }\\ \text{during the year 2017}\end{array}\}\text{=}\frac{\left[\begin{array}{l}\left(\text{Capital}\text{expenditure}\text{during}\text{2016}\text{+}\text{Capitalized}\text{interest}\text{during}\text{2016}\right)\text{+}\\ \left(\text{Accumulated}\text{expenditure}\text{during}\text{2016+}\text{Capital}\text{expenditure}\text{during}\text{2017}\right)\end{array}\right]}{\text{2}}\\ \text{=}\frac{\left[\begin{array}{l}\left(\text{\$6,000,000+\$270,000}\right)\text{+}\\ \left(\text{\$6,270,000+\$11,460,000}\right)\end{array}\right]}{\text{2}}\\ \text{=}\frac{\text{\$24,000,000}}{\text{2}}\\ \text{=}\text{\$12,000,000}\end{array}$

(6)Calculate the average percentage:

$\begin{array}{c}\text{Average}\text{percentage}\text{=}\left[\begin{array}{l}\left(\frac{\text{Amount}\text{borrowed}}{\text{Total}\text{of}\text{other}\text{Amount}\text{borrowed}}\text{×}\text{Interest}\text{rate}\right)\\ \text{+}\left(\frac{\text{Amount}\text{borrowed}}{\text{Total}\text{of}\text{other}\text{amount}\text{borrowed}}\text{×}\text{Interest}\text{rate}\right)\end{array}\right]\\ \text{=}\left[\begin{array}{l}\left(\frac{\text{\$20,000,000}}{\text{\$20,000,000+\$60,000,000}}\text{×10\%}\right)\\ \text{+}\left(\frac{\text{\$60,000,000}}{\text{\$20,000,000+\$60,000,000}}\right)\text{8\%}\end{array}\right]\\ \text{=}\text{8}\text{.5\%}\text{or 0}\text{.085}\end{array}$

(7)Calculate the amount of capitalized interest during the year 2018:

$\begin{array}{c}\text{Capitalized}\text{interest}\text{=}\left[\begin{array}{l}\left(\text{Amount}\text{borrowed×}\text{Rate}\text{of}\text{interest}\right)\text{+}\\ \left(\text{Amount}\text{borrowed×}\text{Rate}\text{of}\text{interest}\right)\end{array}\right]\text{×}\text{Time}\text{peiod}\\ \text{=}\left[\begin{array}{l}\left(\text{\$10,000,000×12\%}\right)\text{+}\\ \left(\text{\$10,000,000×8}\text{.5\%}\right)\end{array}\right]\text{×}\frac{\text{3}}{\text{12}}\\ \text{=}\left[\left(\$1,200,000+\$850,000\right)\times \frac{3}{12}\right]\\ =\$512,500\end{array}$

Note: Interest is capitalized only for 3 months since; the project is completed on March 31, 2012.

(8)Calculate the additional amount to be capitalized during 2018:

$\begin{array}{c}\begin{array}{l}\text{Additional amount to}\\ \text{ be capitalized during 2018}\end{array}\}\text{=}\left(\begin{array}{l}\text{Average}\text{costs}\text{during}\text{the}\text{year}\text{2018}-\\ \text{Amount}\text{borrowed}\text{during}\text{2017}\end{array}\right)\\ \text{=}\text{\$20,000,000}\text{(9)}-\text{\$10,000,000}\\ \text{=\$10,000,000}\end{array}$

(9)Calculate the average costs during the year 2018:

$\begin{array}{c}\begin{array}{l}\text{Average costs }\\ \text{during the year 2018}\end{array}\}\text{=}\frac{\left[\begin{array}{l}\left(\begin{array}{l}\text{Accumulated}\text{expenditure}\text{during}\text{2016+}\\ \text{Capital}\text{expenditure}\text{during}\text{2017+}\\ \text{Capitalized}\text{interest}\text{during}\text{2017}\end{array}\right)\\ \text{+}\left[\begin{array}{l}\text{Accumulated}\text{expenditure}\text{during}\text{2017+}\\ \text{Capital}\text{expenditure}\text{during}\text{2018}\end{array}\right]\end{array}\right]}{\text{2}}\\ \text{=}\frac{\left[\begin{array}{l}\left(\text{\$6,270,000+\$11,460,000+\$1,370,000}\right)\text{+}\\ \left(\text{\$19,100,000+\$1,800,000}\right)\end{array}\right]}{\text{2}}\\ \text{=}\frac{\text{\$40,000,000}}{\text{2}}\\ \text{=}\text{\$20,000,000}\end{array}$

(10)Calculate the amount of interest revenue for the year 2016:

$\begin{array}{c}\text{Interest}\text{revenue=}\left[\left(\begin{array}{l}\text{Amount}\text{borrowed}-\\ \text{Capitalized}\text{interest}\end{array}\right)\text{×}\text{Percentage}\text{of}\text{interest}\right]\\ \text{=}\left[\left(\begin{array}{l}\text{\$10,000,000}-\\ \text{\$3,000,000}\end{array}\right)\text{×11\%}\right]\\ \text{=\$770,000}\end{array}$

(11)Calculate the interest expense for the year 2016:

$\begin{array}{c}\text{Interest}\text{expense}\text{=}\left[\begin{array}{l}\left(\text{Other}\text{borrowings}\text{×}\text{Interest}\text{rate}\right)\text{+}\\ \left(\text{Other}\text{borrowings}\text{×}\text{Interest}\text{rate}\right)\text{+}\\ \left(\text{Other}\text{borrowings}\text{×}\text{Interest}\text{rate}\right)-\\ \text{Capitalized}\text{interest}\text{during}\text{2016}\end{array}\right]\\ \text{=}\left[\begin{array}{l}\left(\text{\$20,000,000×10\%}\right)\text{+}\\ \left(\text{\$60,000,000×8\%}\right)\text{+}\\ \left(\text{\$10,000,000×12\%}\right)\\ -\text{\$270,000}\end{array}\right]\\ \text{=}\left[\left(\begin{array}{l}\text{\$2,000,000+}\\ \text{\$4,800,000}\\ \text{+\$1,200,000}\end{array}\right)-\text{\$270,000}\right]\\ \text{=}\text{\$7,730,000}\end{array}$

(12)Calculate the amount of interest expense during the year 2017:

$\begin{array}{c}\text{Interest}\text{expense}\text{=}\left[\begin{array}{l}\left(\text{Other}\text{borrowings}\text{×}\text{Interest}\text{rate}\right)\text{+}\\ \left(\text{Other}\text{borrowings}\text{×}\text{Interest}\text{rate}\right)\text{+}\\ \left(\text{Other}\text{borrowings}\text{×}\text{Interest}\text{rate}\right)-\\ \text{Capitalized}\text{interest}\text{during}\text{2017}\end{array}\right]\\ \text{=}\left[\begin{array}{l}\left(\text{\$20,000,000×10\%}\right)\text{+}\\ \left(\text{\$60,000,000×8\%}\right)\text{+}\\ \left(\text{\$10,000,000×12\%}\right)-\text{\$1,370,000}\end{array}\right]\\ \text{=}\left[\left(\begin{array}{l}\text{\$2,000,000+}\\ \text{\$4,800,000}\\ \text{+\$1,200,000}\end{array}\right)-\text{\$1,370,000}\right]\\ \text{=}\text{\$6,630,000}\end{array}$

(13)Calculate the amount of interest expense during the year 2018:

$\begin{array}{c}\text{Interest}\text{expense}\text{=}\left[\begin{array}{l}\left(\text{Other}\text{borrowings}\text{×}\text{Interest}\text{rate}\right)\text{+}\\ \left(\text{Other}\text{borrowings}\text{×}\text{Interest}\text{rate}\right)\text{+}\\ \left(\text{Other}\text{borrowings}\text{×}\text{Interest}\text{rate}\right)-\\ \text{Capitalized}\text{interest}\text{during}\text{2018}\end{array}\right]\\ \text{=}\left[\begin{array}{l}\left(\text{\$20,000,000×10\%}\right)\text{+}\\ \left(\text{\$60,000,000×8\%}\right)\text{+}\\ \left(\text{\$10,000,000×12\%}\right)-\text{\$512,500}\end{array}\right]\\ \text{=}\left[\left(\begin{array}{l}\text{\$2,000,000+}\\ \text{\$4,800,000}\\ \text{+\$1,200,000}\end{array}\right)-\text{\$512,500}\right]\\ \text{=}\text{\$7,487,500}\end{array}$

(14)Calculate the amount of cash:

$\begin{array}{c}\text{Interest}\text{expense}\text{=}\left[\begin{array}{l}\left(\text{Other}\text{borrowings}\text{×}\text{Interest}\text{rate}\right)\text{+}\\ \left(\text{Other}\text{borrowings}\text{×}\text{Interest}\text{rate}\right)\text{+}\\ \left(\text{Other}\text{borrowings}\text{×}\text{Interest}\text{rate}\right)\end{array}\right]\\ \text{=}\left[\begin{array}{l}\left(\text{\$20,000,000×10\%}\right)\text{+}\\ \left(\text{\$60,000,000×8\%}\right)\text{+}\\ \left(\text{\$10,000,000×12\%}\right)\end{array}\right]\\ \text{=}\left[\left(\begin{array}{l}\text{\$2,000,000+}\\ \text{\$4,800,000+}\\ \text{\$1,200,000}\end{array}\right)\right]\\ \text{=}\text{\$8,000,000}\end{array}$

(15)Calculate the amount of building:

$\begin{array}{c}\text{Amount}\text{of}\text{building}\text{=}\left[\begin{array}{l}\left(\text{Capital}\text{expenditure}\text{of}\text{year}\text{2016+}\text{Capitalized}\text{interest}\text{during}\text{2016}\right)\text{+}\\ \left(\text{Capital}\text{expenditure}\text{of}\text{year}\text{2017+}\text{Capitalized}\text{interest}\text{during}\text{2017}\right)\text{+}\\ \left(\text{Capital}\text{expenditure}\text{of}\text{year}\text{2018+}\text{Capitalized}\text{interest}\text{during}\text{2018}\right)\end{array}\right]\\ \text{=}\left[\begin{array}{l}\left(\text{\$6,000,000+\$270,000}\right)\text{+}\\ \left(\text{\$11,460,000+\$1,370,000}\right)\text{+}\\ \left(\text{\$1,800,000+\$512,500}\right)\end{array}\right]\\ \text{=}\left(\begin{array}{l}\text{\$6,270,000+}\\ \text{\$12,830,000+}\\ \text{\$2,312,500}\end{array}\right)\\ \text{=\$21,412,500}\end{array}$

2.

To determine

Explain the way in which the answer will change if Company F uses IFRS.

Explanation of Solution

• The total interest costs of loans obtained, precisely for the purpose of constructing a asset are qualified for interest capitalization, under IFRS. Consequently, the total interest expense of construction-related borrowing of $1,200,000 $\left(\$10,000,000\times 12\%\right)$ is entitled for interest capitalization.
• Furthermore, interest revenue from the temporary investment of amounts borrowed specially for construction is offset against interest costs qualified for capitalization. Thus, Company F would capitalize $430,000$\left(\$1,200,000–\$770,000\right)$ .