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2-2 Homework: Chapter 10

1. Ex.10-01 Inclusion in Property, Plant, and Equipment

Guthrie Inc. must determine whether the following items are included in property, plant, and
equipment:

Required:

1. Indicate which items are included in the cost of property, plant, and equipment and
which items are excluded from the cost of property, plant, and equipment.

a. Idle equipment awaiting sale not included

b. Machinery kept on hand and used only when other machinery breaks included

c. Land held for investment not included

d. The right to publish a literary work not included

e. Progress payments on building being constructed by a contractor included

f. Fully depreciated assets still being used included

g. Expenditures to improve leased property included

h. Equipment leased to others not included

i. Purchase of an asset with an expected life of 9 months not included

j. Obligation to remove leasehold improvement at the termination of a lease included

Which of the following is a correct explanation?

I. Idle equipment is held as part of property, plant, and equipment because it will be
used in the company's operations and has an expected life of more than 1 year.

II. The right to publish a literary work is not held as part of property, plant, and
equipment because it will not be used in the company's operations.

III. Land held for investment is not held as part of property, plant, and equipment
because it will not be used in the company's operations.

III only.

2. Ex.10-06 Acquisition of Land and Building

On February 1, 2016, Edwards Corporation purchased a parcel of land as a factory site for
$100,000. It demolished an old building on the property and began construction on a new
building that was completed on October 2, 2016. Costs incurred during this period are:

Demolition of old building $ 8,000

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Architect's fees 25,000

Legal fees for title investigation and purchase contract 4,000

Construction costs 650,000

Edwards sold salvaged materials resulting from the demolition for $2,000.

3. Ex.10-09 Exchange of Assets

Two independent companies, Denver and Bristol, each own a warehouse, and they agree to an
exchange in which no cash changes hands. The following information for the two warehouses is
available:

Denver Bristol

Cost $90,000 $45,000

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Denver Bristol

Accumulated depreciation 55,000 25,000

Fair value 30,000 30,000

Required:

1. Assuming the exchange has commercial substance, prepare journal entries for Denver and
Bristol to record the exchange.

Denver page 9

Bristol page 12

2. Assuming the exchange does not have commercial substance, prepare journal entries for
Denver and Bristol to record the exchange. Denver page 9
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Bristol page 12

3. When an exchange has commercial substance, the economic position of the two companies

significantly changes  . The company’s future cash flows are expected to  increase

as a result of the exchange and gains and losses are  recorded   at the time of the
exchange. If the exchange does not have commercial substance and results in a gain, GAAP
requires the gain to be deferred by reducing   the cost of the new asset. GAAP imposes this
requirement to prevent companies from structuring transactions to exchange economically
equivalent assets simply in order to book a gain in income.

4. wo independent companies, Denver and Bristol, each own a warehouse, and they agree to
an exchange in which no cash changes hands. The following information for the two
warehouses is available:

Denver Bristol

Cost $80,000 $30,500

Accumulated depreciation 58,000 23,000

Fair value 18,500 18,500

Required:

1. Assuming the exchange has commercial substance, prepare journal entries for Denver and
Bristol to record the exchange. Denver pg9
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Bristol pg12

2. Assuming the exchange does not have commercial substance, prepare journal entries for
Denver and Bristol to record the exchange.

Denver pg9

Bristol pg12

3. Next Level What is the justification of accounting for the exchange differently when the
exchange has commercial substance versus when it does not?

When an exchange has commercial substance, the economic position of the two

companies  significantly changes  . The company’s future cash flows are expected

to  increase   as a result of the exchange and gains and losses are  recorded
at the time of the exchange. If the exchange does not have commercial substance and results in
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a gain, GAAP requires the gain to be deferred by  reducing   the cost of the new asset.
GAAP imposes this requirement to prevent companies from structuring transactions to
exchange economically equivalent assets simply in order to book a gain in income.

5. Ex.10-8 Calculating Capitalized Interest

Kit Company borrows $5 million at 12% on January 1, 2016, specifically for the purpose of
financing the construction of a building that is expected to take 18 months to complete. Kit
invests the total amount at 11% until it makes payments for the construction project. During the
first year of construction, Kit incurs the following expenditures related to this construction
project:

January 1 $1,000,000

April 1 1,600,000

October 1 1,200,000

December 31 500,000

Required:

Compute the amount of interest expense Kit would capitalize related to the construction of the
building.

Expenditures Portion of Year Weighted Average

Outstanding Accumulated Expenditures

January 1 $1,000,000 12/12 1000k

April 1 1,600,000 9/12 1200k
October 1 1,200,000 3/12 300k
December 0/12 0
500,000
31
total 4300k 2500k

Avoidable Interest = 2500k * 12% loan interest = 300k

Actual interest = 5000k * 12% = 600k

Capitalized Interest = 300k the lesser of the above 2 interests

Expenditures Amount Months Rate Interest

invested invested earned

5000k 11%
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January 1 $1,000,000 4000k 12/12 0.11 110k

April 1 1,600,000 2400k 9/12 0.11 132k

October 1 1,200,000 1200k 3/12 0.11 33k

December 700k 0/12 0.11 0

500,000
31

total 275k

Compute the amount of interest expense Kit would capitalize related to the construction of the
building. 300,000

Compute the amount of interest revenue Kit would recognize. 275,000

Assume that Kit uses IFRS. What amount of interest would be capitalized related to the
construction of the building? 325,000 = 600k -275k

6. Events Subsequent to Acquisition

The following selected events occurred for Orwell Company during the first quarter of 2016:

Jan. 1 A motor breaks on a machine and is replaced for $2,400. This replacement
1 was expected when the machine was purchased.

Feb. 1 A machine breaks down unexpectedly and requires repairs of $700.

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Mar. 1 An accident damages some equipment. Repairs cost $2,000.

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1 A motor breaks on a machine and is replaced for $900. The new motor is of
9 an improved design that increases the capacity of the machine.

2 Office layout is rearranged at a cost of $700. At the same time, the walls are
7 repainted for $500.

2.Would any of your answers change if the company used IFRS? If so, how?

Under GAAP, the costs of rearranging the facilities within a building or moving them to a new
location are capitalized . Under IFRS, the cost of relocating or reorganizing property, plant, and
equipment is expensed .
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Required:1.Prepare journal entries for the preceding transactions.