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PROBLEM 10.8 (Continued)
3.
Holyfield SA
Machinery ...............................................................
95,000
Liston Company
Machinery ...............................................................
92,000
Accumulated Depreciation—Machinery ...............
75,000
Cash ........................................................................
3,000
4.
Holyfield SA
Machinery ...............................................................
185,000
Accumulated Depreciation—Machinery ...............
60,000
Loss on Disposal of Machinery .............................
8,000
Machinery .......................................................
160,000
Cash ................................................................
93,000
PROBLEM 10.9
(a) Exchange has commercial substance:
Hyde, Ltd.’s Books
Cash ................................................................
15,000
Wiggins, Ltd.’s Books
Cash .........................................................................
15,000
(b) Exchange lacks commercial substance:
Hyde, Ltd.’s Books
PROBLEM 10.9 (Continued)
Wiggins, Ltd.’s Books
Cash ........................................................................
15,000
Asset A (£60,000 – £12,000*) ................................
48,000
PROBLEM 10.10
(a) Has Commercial Substance
Marshall Construction
1.
Equipment (€82,000 + €118,000)......................
200,000
Accumulated Depreciation—Equipment ........
50,000
Brigham Manufacturing
2.
Cash ..................................................................
118,000
Inventory ...........................................................
82,000
(b) Lacks Commercial Substance
Equipment (€82,000 + €118,000 + €8,000*) .....
208,000
Accumulated Depreciation—Equipment ........
50,000
Note: Brigham should record the same entry as in part (a) above. No gain is
deferred because we are assuming that Marshall is a customer.
Problem 10-10 (Continued)
(c) Has Commercial Substance
Marshall Construction
1.
Equipment (€98,000 + €102,000) ......................
200,000
Accumulated Depreciation—Equipment ........
50,000
Equipment ................................................
140,000
Brigham Manufacturing
2.
Cash ................................................................
102,000
Inventory ..........................................................
98,000
(d)
Marshall Construction
1.
Equipment (€200,000 – €7,000*) .....................
193,000
Accumulated Depreciation—Equipment .......
50,000
Brigham Manufacturing
2.
Cash ................................................................
103,000
Inventory ..........................................................
97,000
Sales ........................................................
200,000
PROBLEM 10.11
(a) The major characteristics of plant assets, such as land, buildings, and
equipment, that differentiate them from other types of assets are
presented below.
1. Plant assets are acquired for use in the regular operations of the
enterprise and are not for resale.
(b) Transaction 1. To properly reflect cost, assets purchased on deferred-
payment contracts should be accounted for at the present value of the
Asset cost = Present value of the note + Freight + Installation
PROBLEM 10.11 (Continued)
Transaction 2. The lump-sum purchase of a group of assets should be
accounted for by allocating the total cost among the various assets
Transaction 3. The cost of a non-monetary asset acquired in an
(c) 1. A building purchased for speculative purposes is not a plant
asset as it is not being used in normal operations. The building
is more appropriately classified as an investment.
TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS
CA 10.1 (Time 20–25 minutes)
Purpose—to provide the student with a problem to decide which expenditures related to purchasing
land, constructing a building, and adding to the building should be capitalized and how each should be
depreciated. When the land and building are sold, the student discusses how the book value is
determined and how a gain would be reported.
CA 10.2 (Time 20–25 minutes)
Purpose—to provide the student with a situation involving the proper allocation of costs to self-
CA 10.3 (Time 20–25 minutes)
Purpose—to provide the student with a problem involving the proper accounting treatment for interest
CA 10.4 (Time 30–40 minutes)
Purpose—to provide the student with a situation to determine capitalization of interest and to explain in
a memorandum the conceptual basis for interest capitalization.
CA 10.5 (Time 30–40 minutes)
CA 10.6 (Time 20–25 minutes)
Purpose—to provide the student with an understanding of the proper accounting treatment involving
CA 10.7 (Time 20–25 minutes)
Purpose—to provide the student with a case involving allocation of costs between land and buildings,
including ethical issues.
SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 10.1
(a) Expenditures should be capitalized when they benefit future periods. The cost to acquire the land
should be capitalized and classified as land, a nondepreciable asset. Since tearing down the small
factory is readying the land for its intended use, its cost is part of the cost of the land and should
be capitalized and classified as land. As a result, this cost will not be depreciated as it would if it
were classified with the capitalizable cost of the building.
(b) A gain should be recognized on the sale of the land and building because income is realized
whenever the earning process has been completed and a sale has taken place.
CA 10.2
(a) Materials and direct labor used in the construction of the equipment definitely should be charged to
(b) 1. Many believe that only the variable overhead costs that increase as a result of the construction
should be assigned to the cost of the asset. This approach assumes that the company will
CA 10.2 (Continued)
(c) It could be argued that because costs of development are usually higher on the first few units, the
CA 10.3
Three approaches have been suggested to account for actual interest incurred in financing the
construction or acquisition of property, plant, and equipment. One approach is to capitalize no interest
during construction. Under this approach interest is considered a cost of financing and not a cost of
construction. It is contended that if the company had used equity financing rather than debt financing,
this expense would not have developed. The major arguments against this approach are that an implicit
interest cost is associated with the use of cash regardless of the source.
CA 10.4
To: Jane Edo, President
From: Good Student, Manager of Accounting
Date: January 15, 2020
Subject: Capitalization of avoidable interest on the warehouse
construction project
I am writing in response to your questions about the capitalized interest
costs for the warehouse construction project. This brief explanation of my
calculations should facilitate your understanding of these costs.
Because interest capitalization is allowed in special circumstances only,
the company must be especially careful to capitalize only that interest
which is associated with the construction itself. Thus, the IASB issued a
standard indicating how much interest may be associated with the
construction, i.e., the lower of actual or avoidable interest.
To determine the amount capitalized, we must calculate both the actual
and the avoidable interest during 2018. Actual interest is computed by
applying the interest rates of 12%, 10%, and 11% to their related debt. Thus,
total actual interest for this period is ¥490,000 (see Schedule #1 on page 10-
70).
CA 10.4 (Continued)
Second, of the total ¥4,400,000 debt outstanding during this period, only
¥2,000,000 of it can be associated with the actual construction project.
Therefore, rather than arbitrarily choose the interest rate for one of the other
loans, we must calculate the capitalization rate. This rate is the ratio of
accrued interest on the other loans to the total amount of their principal. For
the ¥1,500,000 balance of weighted-average accumulated expenditures, this
interest rate equals 10.42% (see Schedule #2).
CA 10.4 (Continued)
Schedule #1
Actual Interest
Construction loan
¥2,000,000 X 12% =
¥240,000
Short-term loan
¥1,400,000 X 10% =
140,000
Long-term loan
¥1,000,000 X 11% =
110,000
Total
¥490,000
Total Principal
¥2,400,000
Schedule #3
Avoidable Interest
Weighted-Average
Accumulated Expenditures
X
Interest Rate
=
Avoidable Interest
Schedule #4
Interest Capitalized
Because avoidable interest is lower than actual interest, use avoidable
interest.
CA 10.5
(a) Client A
Treatment if the exchange has commercial substance:
Machinery (£80,000 + £20,000) ..............................................................
100,000
Accumulated Depreciation—Machinery ..................................................
40,000
£100,000.
(b) Treatment if the exchange lacks commercial substance
Client A would be prohibited from recognizing a £20,000 gain on the exchange. This is because
(c) Memo to the Controller:
TO: The Controller
RE: Exchanges of Assets—Commercial Substance Issues.
Financial statement effect of treating the exchange as having commercial substance versus not.
1. The income statement will reflect a before-tax gain of £20,000. This gain will increase the
CA 10.5 (Continued)
(d) Client B
Treatment if the exchange has commercial substance:
Machinery ...............................................................................................
80,000
Accumulated Depreciation—Machinery ..................................................
80,000
Cash .......................................................................................................
20,000
In this situation, the full £30,000 gain would be recognized on this year’s income statement. The new
asset would go on the books at its fair value.
(e) Treatment if the exchange lacks commercial substance
(f) Memo to the Controller:
TO: The Controller
RE: Asset Exchanges—Commercial Substance
1. The income statement will reflect a before-tax gain of £30,000 if the exchange has commercial
substance. This gain will increase the reported income on this year’s financial statements.
CA 10.6
In general, the inclusion of the €7,500 as part of the cost of the machine is justified because the primary
matching of incurred costs with revenue resulting from use of the assets.
(1) It may be true that these installation costs could not be recovered if the machine were to be sold.
This is not important, however, because presumably the machine was acquired to be used, not to
(2) Again, the purpose of accounting for plant assets is not to arrive at an approximation of fair
(3) Assuming that the €7,500 could properly be deducted, there would be some tax savings over the
CA 10.7
(a) If the land is undervalued so that a higher cost is assigned to the building, management interests
are served. The lower net income and reduced tax liability save cash to be used for management
purposes. By contrast, shareholders and potential investors are misled by the inaccurate cost
values. They will have been deprived of information concerning the significant impact of changing
real estate values on this holding.
FINANCIAL STATEMENT ANALYSIS CASE
UNILEVER
(a) The carrying value of land and buildings at the end of 2015 was
€3,108,000,000. The carrying value of the plant and equipment at the
end of 2015 was €7,950,000,000.
(b) As indicated in the footnote number ten to the financial statements,
(c) The cash flow statement reports the amount of interest and
preference dividends paid in cash (€579 million).
(d) Free cash flow is defined as net cash flows provided by operating
activities less capital expenditures and dividends.
For example, the company is able to pay its dividends without resorting
to external financing. Secondly, even if operations decline, it appears
that the company will be able to fund additions to property, plant, and
equipment. Thirdly, the company is using its free cash flow to expand its
operations by acquiring new businesses.
ACCOUNTING, ANALYSIS AND PRINCIPLES
ACCOUNTING
Equipment ($50,000 + $12,000) ..................................... 62,000
ANALYSIS
The gain on the disposal increases income, leading to a one-time increase
in the return on assets (ROA) in the year of the exchange. In essence, the
PRINCIPLES
The concept of commercial substance is a fundamental element in the
accounting for exchanges. If the transaction above lacked commercial sub-
RESEARCH CASE
(a) Yes, it is permissible to capitalize interest into the cost of assets. IAS
23 revised: (http://eifrs.iasb.org/eifrs/bnstandards/en/ias23.pdf.)
(b) The objectives of capitalizing interest are to allow an entity the right to
(c) The following assets qualify for interest capitalization (par. 7):
a. inventories
(d) Yes, there is a limit to the amount of interest capitalized in a period. To
(e) An entity shall disclose:
a. the amount of borrowing costs capitalized during the period; and
b. the capitalization rate used to determine the amount of borrowing
costs eligible for capitalization (par. 26).
