Self question 2 Tumble co had the following
Self question 2 • Tumble co had the following loans in place at the beginning and end of 20 x 8. 1 Jan 20 x 8 31 DEC 20 x 8 $m $m 9% bank loan repayable 20 y 0 150 8% bank loan repayable 20 Y 1 90 90 7. 5% debenture repayable 20 y 2 -- 200
“Loan” not equal to “Expenditure drawn down” Q 2 • The 7. 5 per cent debenture was issued to fund the construction of a qualifying asset( a piece of mining equipment), construction of which began on 1 Jul, 20 X 8. • On 1 Jan 20 X 8 , tumble co began construction of a qualifying asset, a piece of machinery for a hydro-electric plant, using existing borrowings. Expenditure drawn down for the construction was : $25 million on 1 Jan 20 x 8, $30 million on 1 October 20 X 8. • Calculate the borrowing costs that can be capitalized for the hydro-electric plant machine.
Self question 2 answer • Non construction loan Debt Payment Interest Rate Interest Cost Loan 150 m 9% 13. 5 90 m 8% 7. 2 240 (150+90) 8. 6% 20. 7 (13. 5+7. 2) Total • Therefore, the average weight is 8. 6%.
Self question 2 answer • Capitalize for 20 X 8 Expenditure Date Amount Interest Capitalize Fraction of outstanding year Capital 1 Jan 20 x 8 25 m 8. 625% 12/12 2. 156 1 Oct 20 x 8 30 m 7. 5% 8. 625% 2/12 3/12 0. 375 0. 647 3. 5 m 2. 803 In this example, it assumes that the 30 m are also arising from non-construction loan. And, the question gives that the company began using existing borrowing on 1 st January 2008. Three months is counted from 1 October to 31 December as the construction on 1 October 2008.
Self q 2 Debt Interest Rate Accumulated Interest Bank loan repayable 150 m 20 Y 0 9% 13. 5 m Bank loan repayable 90 m 20 Y 1 8% 7. 2 m Debenture repayable 20 Y 2 7. 5% 15 m Total Interest incurred Amount 200 m 12/12 or other months? ? 35. 7 m It can not calculate the total interest cost as the question did not indicate which month the “ 7. 5% debenture repayable 20 y 2” was borrowed.
Self question 3 • On 1 January 20 X 8 Allan Lee Co borrowed $20 million to finance the production of two assets, both of which were expected to take a year to build. Production started at the beginning of 20 x 8. The loan facility was drawn down on 1 January 20 X 8, and was utilized as follows, with the remaining funds invested temporarily:
Self test question 3 The loan rate was 10 per cent and Allan Lee can invest surplus funds at 8 per cent. Required Ignoring compound interest, calculate the borrowing costs which may be capitalized for each of the assets and consequently the cost of each asset as at 31 December 20 X 8
Interest during period of construction Expenditure Date Amount Interest Capitalize Rate Fraction of outstanding Capitalized Jan 1, 20 X 8 10 (4 m +6 m) 10% 12/12 1 Jul 1, 20 X 8 10 10% 5/12 6/12 0. 42 1. 42 m Less investment income 10 (7+3) 8% Borrowing cost Total cost of asset =1. 1+20 m =21. 1 m 6/12 0. 4 1. 1 0. 5 1. 5
Self test question 3 20 10% 2 1. 1 Construction in progress 1. 42 0. 9 Interest Expenses 8. 58 Cash 10 2 In this question, it gives that the 20 millions was borrowed on 1 st January 2008.
Example: Commencement , suspension and cessation of capitalistion Lam Co borrowed $ 10 million on 1 Jan 20 x 8 in anticipation of commencing work to build a new head office later in the year. The interest rate provided by Lam Co’s bank was 8 per cent per annum, and the loan had a term of 5 years. Construction began on 15 Feb and the property was occupied for use on 20 Dec 20 X 8.
Question • 1 Feb Expenditure on building materials began to be incurred • 15 Feb Building materials began. • 6 May Building materials suspense due to tropical storms, common to the region through May and June. • 16 May Building work recommenced • 30 Nov Building work is completed and approved to the regulatory authorities.
Question • 1 Decoration and finishing of the property to Lam Co’s specification commences • 15 Decoration and finishing work is completed. • What journal entries are required to record the borrowing costs in the year ended 31 Dec ?
Answer • The average rate is 8 %. • 15 Feb 8%*10. 5/12 63, 000 9. 5 months is counted from building cost begin (commences) (not just material began to be incurred. Activity need to be in progress. ) to 30 November (not count the tropical storm / decoration and finishing for specification event. Dr Property under construction 630, 000 Dr Finance cost –I/S 170, 000 Cr Cash / interest accrual 800, 000
Practice 10 -5 cost of a self constructed asset (stice) • The company constructed its own building. The cost of materials was $400 000. Labor cost incurred on the construction project was $600 000. Total overhead cost for the company for the year was $ 8 000; total labor cost (including the cost of construction ) was $ 4000000. Interest incurred to finance the construction cost was $ 140 000. Compute the total cost of the building.
Answer • • • Cost of materials 400 000 Labour 600 000 Overhead cost 4 000 1, 200, 000= Interest incurred 140 000 Total cost of building 5140 000 600, 000/4, 000*8, 000 Question states that total overhead cost (construction + non-construction)=8 m Total labour cost (construction + non-construction)=4 m. Construction labour cost =600, 000
P 10 -9 Interest capitalization: specific interest method • On Jan 1 2009, the Company began construction of a building to be used as its office headquarters. The building was completed on Sept 30, 2010. • Expenditure: January 3, 2009 $1, 000 » March 1, 2009 $600, 000 • June 30, 2009 $800, 000 • October 1, 2009 $600, 000 Jan 31, 2010 $270, 000 general Specific April 30, 2010 $585, 000 August 31, 2010 $900, 000 • On January 2, 2009, the company obtained $3 m construction loan with a 10% interest rate. The loan was outstanding all of 2009 and 2010. The company’s other interest bearing debt included two long term notes of $4, 000 and $6, 000 with interest rates of 6% and 8%, respectively. Both notes were outstanding during all of 2009 and 2010. The Company’s fiscal year end is 31 st December.
P 10 -9 Interest capitalization: • • • Date Cost Int. rate Fraction Cap. Int 3 Jan $1, 000 10% 12/12 $100, 000 1 Mar $600, 000 10% 10/12 $50, 000 30 Jun $800, 000 10% 6/12 $40, 000 1 Oct $600, 000 10% 3/12 $15, 000 Total capitalized interest for 2009 $205, 000 -FP
2010 yr: • • P 10 -9 Date Cost Int. rate Fraction Cap. Int 1 Jan 3, 000 10% (9/9)*(9/12) 225, 000 1 Jan 205, 000 7. 2% (9/9) *(9/12) 11, 070 31 Jan 270, 000 7. 2% (8/9) *(9/12) $12, 960 30 Apr 585, 000 7. 2% (5/9) *(9/12) 17, 550 31 Aug 900, 000 7. 2% (1/9) *(9/12) 5, 400 Total capitalized interest for 2010 $ 271, 980 PRINCIPLE RATE 4, 000 6% 240, 000 6, 000 8% 480, 000 10, 000 720, 000 Average rate : 720, 000/ 10, 000 =7. 2%
• 2009: Dr. Construction in Progress 205, 000 • Interest expense 815, 000 • Cr. Cash 1, 020, 000 • 2010: Dr. Construction in Progress 271, 980 • Interest expense 748, 020 • Cr. Cash 1, 020, 000 (x 1, 034, 760)(to Bank) • • 1, 020, 000 +205, 000*7. 2%=14, 760 +1, 020, 000 =1, 034, 760 Compound= Last year interest has not been paid. This year amount interest include L. Y. unpaid interest
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