Chapter 8

Topics: Depreciation, Construction, Book value Pages: 8 (1285 words) Published: December 4, 2013
Columbia Company, which manufactures machine tools, had the following transactions related to plant assets in 2014. Asset A: On June 2, 2014, Columbia purchased a stamping machine at a retail price of $12,000. Columbia paid 6% sales tax on this purchase. Columbia paid a contractor $2,800 for a specially wired platform for the machine, to ensure noninterrupted power to the machine. Columbia estimates the machine will have a 4-year useful life, with a salvage value of $2,000 at the end of 4 years. The machine was put into use on July 1, 2014. Asset B: On January 1, 2014, Columbia, Inc. signed a fixed-price contract for construction of a warehouse facility at a cost of $1,000,000. It was estimated that the project will be completed by December 31, 2014. On March 1, 2014, to finance the construction cost, Columbia borrowed $1,000,000 payable April 1, 2015, plus interest at the rate of 10%. During 2014, Columbia made deposit and progress payments totaling $750,000 under the contract; the weighted-average amount of accumulated expenditures was $400,000 for the year. The excess-borrowed funds were invested in short-term securities, from which Columbia realized investment revenue of $13,000. The warehouse was completed on December 1, 2014, at which time Columbia made the final payment to the contractor. Columbia estimates the warehouse will have a 25-year useful life, with a salvage value of $20,000. Columbia uses straight-line depreciation and employs the “half-year” convention in accounting for partial-year depreciation. Columbia's fiscal year ends on December 31. Instructions

(a) At what amount should Columbia record the acquisition cost of the machine? (b) What amount of capitalized interest should Columbia include in the cost of the warehouse? (c) On July 1, 2016, Columbia decides to outsource its stamping operation to Medek, Inc. As part of this plan, Columbia sells the machine (and the platform) to Medek, Inc. for $7,000. What is the impact of this disposal on Columbia's 2016 income before taxes? Solution

(a) Historical cost is measured by the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition for its intended use. For Columbia, this is: Price$12,000

Tax 720

Since Columbia has outstanding debt incurred specifically for the construction project, in an amount greater than the weighted-average accumulated expenditures of $400,000, the interest rate of 10% is used for capitalization purposes. Capitalization stops upon completion of the project at December 31, 2014. Therefore, the avoidable interest is $40,000, which is less than the actual interest. The investment revenue of $13,000 is irrelevant to the question addressed in this problem because such interest earned on the unexpended portion of the loan is not to be offset against the amount eligible for capitalization.

(c) The income effect is a gain or loss, determined by comparing the book value of the asset to the disposal value: Cost$15,520 
Less: Accumulated depreciation 6,760*

Book value of machine and platform8,760 
Less: Cash received for machine and platform7,000 
Loss before income taxes$ 1,760 

2014: ½ year $1,690
2015: full year3,380
2016: ½ year1,690

Exercise 10-5
Ben Sisko Supply Company, a newly formed corporation, incurred the following expenditures related to Land, to Buildings, and to Machinery and Equipment. Abstract company’s fee for title search$728

Architect’s fees4,438
Cash paid for land and dilapidated building thereon121,800 Removal of old building$28,000
Less: Salvage7,70020,300
Interest on short-term loans during construction10,360
Excavation before construction for basement26,600
Machinery purchased (subject to 2% cash discount,...
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