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HG Co. was recently incorporated on January 1, 2017. To assist with the construction of the entity’s office building the loan was obtained from the Bank of America. The entity took out a loan of $250 million dollars March 1, 2017. The effective interest rate on the loan is 8% per annum. The loan as well as the interest is to be repaid in a single installment on February 28, 2027. Construction commenced on April 1, 2017 and was completed on September 30, 2017. The construction of the building amounted to:
Direct material $250 million
Direct Labour $150 million
Overheads $200 million
Fifty percent of the overheads related to cost overruns and inefficiency on the part of the contractor, as a result of his inexperience in constructing the new state of the art building in Freeport. The building was brought into operation on the date of completion and is expected to have a useful life of fifty years from that date. All assets are depreciated using a straight-line basis to a residual value of nil. The building, which was the entity’s only asset during the first two
years of operations was financed by debt and equity.
Required:
a) Prepare the relevant financial statement extracts showing clearly the carrying value
of the building, financing and the results of operation as at for the period ending
December 31, 2017—ignore the statement of changes in equity.
b) Prepare the relevant financial statement extracts showing clearly the carrying value
of the building, financing and the results of operation as at for the period ending
December 31, 2018—ignore the statement of changes in equity.Hi,
What are you specifically having difficulties with? I can’t just go through and answer the entire question. If you let me know what you’re having difficulty with and what attempt you’ve made at the question already then I can gladly help you out.
Thanks
OK, that sounds like a plan. Look forward to hearing back from you. The key to the borrowing cost element here is the dates of when construction starts and ends as that is when you’re able to capitalise. Then you also need to look at the PPE cost element, so use the information given regarding what does/doesn’t relate directly to the PPE.
Good luck!
Hi again,
Ok, so far I got $510 mil for the value of the asset (direct labour + direct materials + 50% overhead + capitalized borrowing cost).
So for 2017, interest incurred for Mar 1 – Dec 31 is $16,666,667 and for Apr 1 – Sep 30 (capitalization period) is $10,000,000.
Depreciation for Sep 30 – Dec 31 is $2,550,000.
The finance cost is $6,666,667, the overhead expense is $100 mil and the carrying value is $507.45 mil. Loan value remains at $250 mil.As for 2018, interest incurred (finance cost) is $20,000,000 and depreciation is $10,200,000.
Accumulated depreciation is $12.75 mil and carrying value is $497.25 milI’m wondering if the interest is to be repaid in a single installment has any effect. We would still accrue yearly and should the other 50% of overhead cost be added?
Thank You
Top work! Really impressed with what you’ve done. You’ve got the easy part in the value of the PPE without the capitalised borrowing costs and then have dealt with the hardest bit, the borrowing costs, correctly.
Although the loan was in place for 9 months of the year April to December, we can only capitalise from April to September (6 months) per IAS 23.
The loan being paid in one installment is just trying to make it easier as it we paid it in installments then the calculation would be much more challenging. As we make payments, the interest would decrease and would impact the amounts capitalised if we were constructing the PPE.
The disappointing news though is that I doubt you would see something this challenging in the exam…….
Thanks
Thank you!
One more thing, in the SoFP, should I add the accrued interest as a current liability? $6,666,667 for 2017 and $26,666,667 for 2018?
Also, should we calculate borrowing cost from when the loan is received or when construction commences?@melissa77 which book did you get this question from?
@AccountingStar My lecturer gave it to us. I’m not sure where she got it from.
TryingCPA wrote:Thank you!
If the interest hasn’t been paid then it would be accrued as a current liability.
Capitalised borrowing costs are from when all the criteria are met, i.e. incurring interest, costs incurred and construction started.
Thanks
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