Chapter 10 In-class Problems DAY 3

Problem #1 (P10-9)

On January 1, 2018, the Mason Manufacturing Company began construction of a building to be used as its office
headquarters. The building was completed on September 30, 2019.
 
Expenditures on the project were as follows:
 
      
January 1, 2018 $1,000,000 
March 1, 2018   600,000 
June 30, 2018   800,000 
October 1, 2018   600,000 
January 31, 2019   270,000 
April 30, 2019   585,000 
August 31, 2019   900,000 

 
On January 1, 2018, the company obtained a $3 million construction loan with a 10% interest rate. The loan was
outstanding all of 2018 and 2019. The company’s other interest-bearing debt included two long-term notes of
$4,000,000 and $6,000,000 with interest rates of 6% and 8%, respectively. Both notes were outstanding during all of
2018 and 2019. Interest is paid annually on all debt. The company’s fiscal year-end is December 31.
 
1. Calculate the amount of interest that Mason should capitalize in 2018 and 2019 using the specific interest
method.
2. What is the total cost of the building?
3. Calculate the amount of interest expense that will appear in the 2018 and 2019 income statements.

1.
2018:
Expenditures for 2018:
1,000,00 1,000,00
January 1, 2018 $ ×12/12=$  
0 0
March 1, 2018   600,000×10/12=   500,000 
June 30, 2018   800,000× 6/12=   400,000 
October 1, 2018   600,000× 3/12=   150,000 
Accumulated expenditures 3,000,00
         
(before interest) $ 0
2,050,00
Average accumulated expenditures -      $  
0

 
Interest capitalized:
$2,050,000 × 10%  =  $205,000 = Interest capitalized in 2018
 
2019:
January 1, 2019             
3,205,00
($3,000,000 + $205,000) $3,205,000×9/9=$  
0
January 31, 2019   270,000×8/9=   240,000 
April 30, 2019   585,000×5/9=   325,000 
August 31, 2019   900,000×1/9=   100,000 
Accumulated expenditures
         
(before interest) $4,960,000
 3,870,00
Average accumulated expenditures -      $  
0

Interest capitalized:
   
  $3,870,000                   
  –3,000,000 (construction loan) × 10.0% × 9/12 = $ 225,000  
    870,000  × 7.2%* × 9/12 =   46,980  
      Interest capitalized in 2019   $ 271,980  

*Weighted-average rate of all other debt:

 
 
  $ 4,000,000 × 6 % = $ 240,000  
    6,000,000 × 8 % =   480,000  
  $10,000,000        $ 720,000  

 
$720,000
= 7.2%
$10,000,000

2.
      
Accumulated expenditures 9/30/2019     
4,960,00
before interest capitalization (above) $  
0
2019 interest capitalized (above)   271,980 
5,231,98
Total cost of building $  
0

3.
 
2018  
$ 3,000,000  × 10% = $ 300,000  
  4,000,000  × 6% =   240,000  
  6,000,000  × 8% =   480,000  
Total interest incurred  1,020,000  
Less: Interest capitalized   (205,000) 
2018 interest expense$ 815,000  
2019  
Total interest incurred $1,020,000  
Less: Interest capitalized   (271,980) 
2019 interest expense$ 748,020  
Problem #2 (P10-11)

In 2018, Starsearch Corporation began work on three research and development projects. One of the projects was
completed and commercial production of the developed product began in December. The company's fiscal year-end
is December 31. All of the following 2018 expenditures were included in the R&D expense account:
 
   
Salaries and wages for:  
Lab research $ 300,000 
Design and construction of preproduction prototype  160,000 
Quality control during commercial production   20,000 
Materials and supplies consumed for:     
Lab research   60,000 
Construction of preproduction prototype   30,000 
Purchase of equipment   600,000 
Patent filing and legal fees for completed project   40,000 
Payments to others for research   120,000 
Total $1,330,000 

 
$200,000 of equipment was purchased solely for use in one of the projects. After the project is completed, the
equipment will be abandoned. The remaining $400,000 in equipment will be used on future R&D projects. The
useful life of equipment is five years. Assume that all of the equipment was acquired at the beginning of the year.
 
Prepare journal entries, reclassifying amounts in R&D expense, to reflect the appropriate treatment of the
expenditures.

No Event General Journal Debit Credit

1 1 Equipment 400,000
Research and development expense 400,000

2 2 Research and development expense 80,000

Accumulated depreciation—equipment 80,000

3 3 Patent 40,000
Research and development expense 40,000

4 4 Inventory 20,000
Research and development expense 20,000

2
To record depreciation on equipment used in R&D projects.
$400,000 ÷ 5 years = $80,000
  
4
Inventory:
Quality control costs would either be treated as manufacturing overhead and included in the cost of inventory (as in
this journal entry), or expensed in the period incurred.