Long Term Operating Assets
Practice As You Learn
Practice as You Learn
Long Term Assets – Practice Problem 1 – Capitalize or Expense
A company had the following expenditures:
| Purchase price of a building | $250,000 |
| Purchase price of land | $125,000 |
| Purchase price of equipment | $ 65,000 |
| Legal fees for a trademark to outside attorneys | $ 12,000 |
| Excess paid for a company above net value of assets | $100,000 |
| Routine maintenance for the equipment | $ 8,000 |
| Prior year property taxes on the building | $ 22,000 |
| Real estate commission on the land | $ 10,000 |
| Shipping expense for the equipment | $ 3,200 |
| Survey costs related to the land | $ 2,800 |
| Training on the equipment during the year in use | $ 5,200 |
| Salaries of employees working on the trademark | $ 7,400 |
| Installation of the equipment | $ 6,500 |
| Real estate commission on the building | $ 18,000 |
| Bulldozing costs related to the land | $ 7,200 |
| Architect fees related to the building | $ 2,900 |
| Insurance for the building for the first month used | $ 800 |
| Remodel of the building before use | $ 13,400 |
| Removal of a building on the land purchased | $ 8,300 |
| Engine upgrade on the equipment – extends life 5 years | $ 9,200 |
| Training on the equipment prior to use | $ 1,200 |
| Property tax on the land for this year | $ 4,400 |
Determine the cost of the building, land, equipment, and trademark
Record the acquisition of the assets.
Answer
1st – sort the expenditure according to the asset it is related to
Building
| Purchase price of a building | $250,000 |
| Prior year property taxes on the building | $ 22,000 |
| Real estate commission on the building | $ 18,000 |
| Architect fees related to the building | $ 2,900 |
| Insurance for the building for the first month used | $ 800 |
| Remodel of the building before use | $ 13,400 |
Land
| Purchase price of land | $125,000 |
| Real estate commission on the land | $ 10,000 |
| Survey costs related to the land | $ 2,800 |
| Bulldozing costs related to the land | $ 7,200 |
| Removal of a building on the land purchased | $ 8,300 |
| Property tax on the land for this year | $ 4,400 |
Equipment
| Purchase price of equipment | $ 65,000 |
| Routine maintenance for the equipment | $ 8,000 |
| Shipping expense for the equipment | $ 3,200 |
| Training on the equipment during the year in use | $ 5,200 |
| Installation of the equipment | $ 6,500 |
| Engine upgrade on the equipment – extends life 5 years | $ 9,200 |
| Training on the equipment prior to use | $ 1,200 |
Trademark
| Legal fees for a trademark paid to outside attorneys | $ 12,000 |
| Salaries of employees working on the trademark | $ 7,400 |
Goodwill:
| Excess paid for a company above net value of assets | $100,000 |
2nd – For each item on the list apply the rule and determine if it is capitalized (C)
or expensed (E):
Property/Plant/Equipment:
Capitalize: Incurred before using the asset
After use when it extends the life or improves efficiency
Intangible Assets:
Capitalize: Paid outside the company
Expense: Paid to workers inside the company (salaries)
Building
| Purchase price of a building | $250,000 (C) |
| Prior year property taxes on the building | $ 22,000 (C) |
| Real estate commission on the building | $ 18,000 (C) |
| Architect fees related to the building | $ 2,900 (C) |
| Insurance for the building for the first month used | $ 800 (E) |
| Remodel of the building before use | $ 13,400 (C) |
Land
| Purchase price of land | $125,000 (C) |
| Real estate commission on the land | $ 10,000 (C) |
| Survey costs related to the land | $ 2,800 (C) |
| Bulldozing costs related to the land | $ 7,200 (C) |
| Removal of a building on the land purchased | $ 8,300 (C) |
| Property tax on the land for this year | $ 4,400 (E) |
Equipment
| Purchase price of equipment | $ 65,000 (C) |
| Routine maintenance for the equipment | $ 8,000 (E) |
| Shipping expense for the equipment | $ 3,200 (C) |
| Training on the equipment during the year in use | $ 5,200 (E) |
| Installation of the equipment | $ 6,500 (C) |
| Engine upgrade on the equipment – extends life 5 years | $ 9,200 (C) |
| Training on the equipment prior to use | $ 1,200 (C) |
Trademark
| Legal fees for a trademark | $ 12,000 (C) |
| Salaries of employees working on the trademark | $ 7,400 (E) |
Goodwill:
| Excess paid for a company above net value of assets | $100,000 (C) |
3rd – Add up all the amounts that are capitalized to get the total cost of the asset.
This total cost will be the amount that is used to get depreciation expense
for the building and the equipment and amortization expense for the trademark.
| Building | Land | Equipment | Trademark | Goodwill |
| $306,300 | $153,300 | $85,100 | $12,000 | $100,000 |
4th – Record the journal entries related to the cost of the asset:
| Building $306,300 Cash $306,300 Land $153,300 Equipment $85,100 Trademark $12,000 Goodwill $100,000 |
Important: All costs that are capitalized are recorded directly to the asset.
Long Term Assets – Practice Problem 2 – Compute Capitalized Interest
A company is constructing a manufacturing facility. To finance the facility the company borrowed $1,500,000 from the bank at an annual interest rate of 7% on March 1st. The company has other long-term bank financing borrowed in the prior year in the amount of $1,000,000 at an annual interest rate of 8%. Construction began on March 1stof the current year and ended on August 31st of the following year. Payments made to the contractor were as follows:
| March 31st | $ 500,000 |
| June 30th | $ 900,000 |
| December 31st | $1,600,000 |
| July 31st | $ 500,000 |
| Total Cost | $3,500,000 |
Make all the required entries for the current year and the second year related to the construction of the manufacturing facility.
Answer
1st: Compute the average expenditures for both years:
Current Year:
| March 31st | $ 500,000 x 9/12 | = | $375,000 |
| June 30th | $ 900,000 x 6/12 | = | $450,000 |
| December 31st | $1,600,000 x 0/12 | = | $ 0 |
| Weighted Average | $825,000 |
2nd Year – January 1st through August 31st:
| March 31st , PY | $ 500,000 x 8/12 | = | $ 333,333 |
| June 30th , PY | $ 900,000 x 8/12 | = | $ 600,000 |
| December 31st PY | $1,600,000 x 8/12 | = | $1,066,667 |
| July 31st | $ 500,000 x 1/12 | = | $ 41,667 |
| Weighted Average | $2,041,667 | ||
2nd: Compute the interest expense related to weighted average expenditures:
Current Year:
| Weighted Average $825,000 x Annual Interest Rate .07 = Related Interest Expense $ 57,750 |
The total average expenditures are less than the $1,500,000 borrowed to finance the construction, so use the interest rate associated with that specific borrowing
2nd Year:
| Construction Loan | $1,500,000 x 7% | $105,000 |
| Other borrowings | $ 541,667 x 8% | $ 43,333 |
| Total expenditures | $2,041,667 | $148,333 |
The total average expenditures exceed the amount that was borrowed to finance the construction. The 7% interest rate is used for the amount of the construction loan and the other amount of $514,667, the amount it takes to get to the total average expenditures, is computed at the rate of the other long-term borrowings.
3rd: Record the payments to the contractor for each year and the interest expense:
Current Year
| Manufacturing Plant 3,000,000 Cash 3,000,000 Manufacturing Plant 57,750 |
Next Year:
| Manufacturing Plant 500,000 Cash 500,000 Manufacturing Plant 123,333 |
Note: The computed interest expense is higher than the interest expense actually incurred during the period of construction.
Capitalized interest cannot be higher than the interest actually incurred.
Record the amount of interest expense actually incurred.
The amount of capitalized interest must not exceed actual interest paid during the time of the project. Compute total interest paid and record this amount if the computed amount for the construction project is higher.
Current Year:
| 1,500,000 x 7% x 9/12 = 78,750 1,000,000 x 8% x 9/12 = 60,000 Total interest expense 138,750 |
Second Year – through 8/31 completion:
| 1,500,000 x 7% x 8/12 = 70,000 1,000,000 x 8% x 8/12 = 53,333 Total interest expense 123,333 |
Important to note: When the company’s borrowings are not specified for construction, you must compute an average borrowing rate and use this rate to compute the capitalized interest amount:
Compute the weighted average borrowing rate:
| Borrowings Interest Expense
1,500,000 x 7% = 105,000 Interest Expense 185,000 = 7.4% |
Use 7.4% cost of borrowing when the loans are not specific to construction.
Long Term Assets – Practice Problem 3 – Record the exchange of an asset
A company purchased an automobile for its salesman that had a cash purchase price of $27,000. The auto previously used had an appraised market value of $12,000 and was traded for the new auto along with $3,000 cash. Historical cost and accumulated depreciation for the old auto were $24,000 and $12,500.
Make the journal entry to record the exchange of the auto.
Answer
1st:
Record the new asset at the more readily determinable FMV + cash paid or less cash received
The fair market value of the asset received is more readily determinable.
Cash price is more reliable than appraised value.
Use the more readily determinable fair market value to record the new auto.
Cash price 27,000 + cash paid 3,000 = 30,000
2nd Remove the old asset using historical cost and accumulated deprecation
3rd Record a loss (debit) or gain (credit) for the amount that it takes to balance
the journal entry
| Automobile (new) 30,000 Accumulated depreciation 12,500 Automobile (old) 24,000 Cash 3,000 Gain on exchange 15,500 |
Long Term Assets – Practice Problem 4 – Record a lump sum purchase
The company paid $250,000 for an office building, a parking lot, and an additional 5 acres of land. The fair market value of the office building was $124,000 at the time of purchase. The parking lot and 5 acres of land had a fair market value of $30,000 and $150,000 respectively.
Make the journal entry to record the purchase of the assets.
Answer
1st: Using FMV of each asset, determine the % of the total for each asset:
| Asset | FMV | % of Total |
| Office Building | 124,000 | .408 |
| Parking Lot | 30,000 | .099 |
| 5 Acres of Land | 150,000 | .493 |
| Total | 304,000 | 1.00 |
2nd: Using the allocated FMV percentage to allocate the amount paid to each asset:
| Asset | Paid | % of Total | Allocated Cost |
| Office Building | 250,000 | .408 | 102,000 |
| Parking Lot | 250,000 | .099 | 24,750 |
| 5 Acres of Land | 250,000 | .493 | 123,250 |
| Total | 1.00 | 250,000 |
3rd: Record the purchase using the allocated costs to each asset
| Building 102,000 Parking Lot 24,750 Land 123,250 Cash 250,000 |