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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Interest During Construction Foothills Power Company begins a 2-year construction project on a power plant on January 1, 2019. The following information is available:

  • The company borrows $10 million on January 1, 2019, at 12%, specifically for use on the project.
  • The company’s other borrowings are:
  • $20 million at 10%
  • $60 million at 8%
  • The expenditures for the project, incurred evenly each year (excluding capitalized interest from previous years), are as follows:
  • $6,000,000 in 2019
  • $11,460,000 in 2020
  • $1,800,000 in 2021
  • The project is completed on March 31, 2021. It took longer than originally planned because the company suspended construction for the last 3 months of 2019 because of a concern about the salability of the electricity produced by the plant.
  • Because of reduced demand for electricity, the plant does not begin operations until October 1, 2021.
  • The company invests at 11% the unused amounts of the $10 million borrowed specifically for the project.
  • Assume all transactions are in cash unless otherwise indicated.

Required:

  1. 1. Prepare all the necessary journal entries for each of the 3 years. Record all construction costs in a Construction in Progress inventory account.
  2. 2. How would your answer change if Foothills used IFRS?

1.

To determine

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

Explanation

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, 2019, 2020, 2021:

DateAccount titles and explanationDebit ($)Credit ($)
 2019Construction in Progress  6,000,000 
      Cash 6,000,000
 (To record the construction in progress)  
    
  2019Cash (10)770,000 
      Interest Revenue  770,000
 (To record the interest revenue)  
    
  2019Interest Expense (11)7,730,000 
 Construction in Progress (1)270,000 
      Cash (14) 8,000,000
 (To record interest expense)  
    
 2020Construction in Progress11,460,000 
      Cash 11,460,000
 (To record the construction in progress)  
    
 2020Interest Expense (12)6,630,000 
 Construction in Progress (3)1,370,000 
      Cash 8,000,000
 (To record interest expense)  
    
 2021Construction in Progress1,800,000 
      Cash 1,800,000
 (To record the construction in progress)  
    
 2021Interest Expense (13)7,487,500 
 Construction in Progress (7)512,500 
      Cash 8,000,000
 (To record the interest expense)  
    
 2021Building (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 2019:

Constructioninprogress}=(Averagecosts×percentageofinterests×Timeperiod)=$3,000,000(2)×12%×912=$270,000

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 2019:

Averagecosts=(Beginningcumulativecosts+Endingcumulativecosts)2=($0+$6,000,000)2=$3,000,000

(3)Calculate the amount of capitalized interest for the year 2020:

Capitalizedinterest=[(Amountborrowedduring2019×Interestrate)+(AdditionalAmounttobecapitalizedduring2020×Interestrate)]=[($10,000,000×12%)+($2,000,000(4)×8.5% (6))]=$1,370,000

(4)Calculate the additional amount to be capitalized during 2020:

Additional amount to be capitalized during 2020}=(Averagecostsduringtheyear2020Amountborrowedduring2019)=$12,000,000(5)$10,000,000=$2,000,000

(5)Calculate the average costs during the year 2020:

Average costs during the year 2020}=[(Capitalexpenditureduring2019+Capitalizedinterestduring2019)+(Accumulatedexpenditureduring2019+Capitalexpenditureduring2020)]2=[($6,000,000+$270,000)+($6,270,000+$11,460,000)]2=$24,000,0002=$12,000,000

(6)Calculate the average percentage:

Averagepercentage=[(AmountborrowedTotalofotherAmountborrowed×Interestrate)+(AmountborrowedTotalofotheramountborrowed×Interestrate)]=[($20,000,000$20,000,000+$60,000,000×10%)+($60,000,000$20,000,000+$60,000,000)8%]=8.5%or 0.085

(7)Calculate the amount of capitalized interest during the year 2021:

Capitalizedinterest=[(Amountborrowed×Rateofinterest)+(Amountborrowed×Rateofinterest)]×Timepeiod=[($10,000,000×12%)+($10,000,000×8.5%)]×312=[($1,200,000+$850,000)×312]=$512,500

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

2.

To determine

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

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