D104 OA 1 LQT UPDATED QUESTIONS AND CORRECT
ANSWERS
Question:
1. Watauga Company had the fol-lowing events:
Purchase of equipment on July 1, 2017 for $70,000 Sales tax on the purchase was $700 Other costs of
freight charges of $800 Insurance during shipping of $150 Repairs of $1,300 for damage during
installation Installation costs of $1,050 What is the cost of the equip-ment?
Answer:
The cost of a piece of equipment includes all expenditures incurred in acquiring the equipment and
preparing it for use. Therefore the cost includes the cost of $70,000, sales tax of $700, freight charges
of $800, insurance of $ 150, and installation costs of $1,050. The repair costs of $1,300 are expensed
and not included in the capitalized cost of the equipment. The reasons the the repairs of damage
during installation are not included in the capitalized costs include such repairs should either be
warrantied by the company performing the installation and therefore would be reimbursable from that
company or those repairs could be reimbursable by the com-pany's or the suppliers insurance policy.
Cost of equipment: $72,700
Question:
2. Cotton Hotel Corporation re-cently purchased Emporia Ho-tel and the land on which it is located
with the plan to tear down the Emporia Hotel and build a new luxury hotel on the site. How should
the cost of the Em-poria Hotel be treated?
Answer:
If a company purchases land with an old building on it, then the cost of demolition less its salvage
value is a cost of getting the land ready for its intended use and relates to the land rather than to the
new building. Therefore, the cost of the Emporia hotel is capitalized as part of the cost of the land.
Question:
3. How are fences and parking lots reported on the balance sheet?
Answer:
Improvements with limited lives, such as driveways, walks, fences, and parking lots are classified on
the balance sheet as Land Improvements and depreciated over their estimated lives. Reported on the
balance sheet as "Land Improvements"
Question:
4. Land was purchased to be used as the site for the construction of a plant. A building on the property
was sold and removed by the buyer so that construc-tion on the plant could begin. 'How should the
proceeds from the sale of the building be treat-ed?
Answer:
If a company purchases land with an old building on it, then the cost of demolition less its salvage
value is a cost of getting the land ready for its intended use and relates to the land rather than to the
new building. Therefore, the proceeds from the sale of the old building is deducted from the cost of
the land. So, the proceeds should be deducted from the cost of the land.
, Question:
5. Wilson Co. purchased land as a factory site for $1,350,000. Wilson paid $120,000 to tear down two
buildings on the land. Salvage was sold for $8,100. Legal fees of $5,220 were paid for title
investigation and mak-ing the purchase. Architect's fees were $46,800. Title insurance cost $3,600,
and liability insurance during con-struction cost $3,900. Excavation cost $15,660. The contractor was
paid $4,200,000. An assessment made by the city for pavement was $9,600. At what cost should
Wilson Co record the land?
Answer:
Removal of old buildings—clearing, grading, and filling—is a land cost because this activity is
necessary to get the land in condition for its intended purpose. Architect Fees, liability insurance, and
excavation are included in the cost of the building. Therefore, the cost of the land is calculated as:
$1,350,000 + $120,000 - $8,100 + $5,220 + $3,600 + $9,600 = $1,480,320. The excavation cost of
$15,660 is a cost related to the build-ing, not to the acquisition of the land, as the excavation cost is
directly related to building the building on the land. So, the Wilson Co should record the cost of land
at $1,480,320
Question:
6. How does GAAP recommend accounting for interest costs in-curred during construction?
Answer:
Using this approach ignores the implicit interest cost associ-ated with the use of the cash. GAAP
requires only the actual interest costs incurred during construction be capitalized. This method
follows the historical cost principle. So you should capitalize the actual interest cost for the period
incurred during the period.
Question:
7. What assets qualify for interest cost capitalization?
Answer:
For the purposes of interest cost capitalization, qualifying assets must require a period of time to get
the asset ready for their intended purposes. Assets that do not qualify include assets that are currently
in use, assets that are ready for their intended use, or assets that are not in use due to excess capacity
or obsolescence. So, assets that are under construction for a company's own use.
Question:
8. When computing the amount of interest cost to be capital-ized, What does the concept of
"avoidable interest" refer to?
Answer:
Avoidable interest is the amount of interest cost during the period that a company could theoretically
avoid if it had not made the decision to purchase the asset in the first place. So, avoidable interest
refers to that portion of total interest cost which would not have been incurred if expenditures for
asset construction had not been made
Question:
9. What best describes the correct treatment of the interest costs capitalized during the period of
construction when a company purchases land as a site for a plant?
ANSWERS
Question:
1. Watauga Company had the fol-lowing events:
Purchase of equipment on July 1, 2017 for $70,000 Sales tax on the purchase was $700 Other costs of
freight charges of $800 Insurance during shipping of $150 Repairs of $1,300 for damage during
installation Installation costs of $1,050 What is the cost of the equip-ment?
Answer:
The cost of a piece of equipment includes all expenditures incurred in acquiring the equipment and
preparing it for use. Therefore the cost includes the cost of $70,000, sales tax of $700, freight charges
of $800, insurance of $ 150, and installation costs of $1,050. The repair costs of $1,300 are expensed
and not included in the capitalized cost of the equipment. The reasons the the repairs of damage
during installation are not included in the capitalized costs include such repairs should either be
warrantied by the company performing the installation and therefore would be reimbursable from that
company or those repairs could be reimbursable by the com-pany's or the suppliers insurance policy.
Cost of equipment: $72,700
Question:
2. Cotton Hotel Corporation re-cently purchased Emporia Ho-tel and the land on which it is located
with the plan to tear down the Emporia Hotel and build a new luxury hotel on the site. How should
the cost of the Em-poria Hotel be treated?
Answer:
If a company purchases land with an old building on it, then the cost of demolition less its salvage
value is a cost of getting the land ready for its intended use and relates to the land rather than to the
new building. Therefore, the cost of the Emporia hotel is capitalized as part of the cost of the land.
Question:
3. How are fences and parking lots reported on the balance sheet?
Answer:
Improvements with limited lives, such as driveways, walks, fences, and parking lots are classified on
the balance sheet as Land Improvements and depreciated over their estimated lives. Reported on the
balance sheet as "Land Improvements"
Question:
4. Land was purchased to be used as the site for the construction of a plant. A building on the property
was sold and removed by the buyer so that construc-tion on the plant could begin. 'How should the
proceeds from the sale of the building be treat-ed?
Answer:
If a company purchases land with an old building on it, then the cost of demolition less its salvage
value is a cost of getting the land ready for its intended use and relates to the land rather than to the
new building. Therefore, the proceeds from the sale of the old building is deducted from the cost of
the land. So, the proceeds should be deducted from the cost of the land.
, Question:
5. Wilson Co. purchased land as a factory site for $1,350,000. Wilson paid $120,000 to tear down two
buildings on the land. Salvage was sold for $8,100. Legal fees of $5,220 were paid for title
investigation and mak-ing the purchase. Architect's fees were $46,800. Title insurance cost $3,600,
and liability insurance during con-struction cost $3,900. Excavation cost $15,660. The contractor was
paid $4,200,000. An assessment made by the city for pavement was $9,600. At what cost should
Wilson Co record the land?
Answer:
Removal of old buildings—clearing, grading, and filling—is a land cost because this activity is
necessary to get the land in condition for its intended purpose. Architect Fees, liability insurance, and
excavation are included in the cost of the building. Therefore, the cost of the land is calculated as:
$1,350,000 + $120,000 - $8,100 + $5,220 + $3,600 + $9,600 = $1,480,320. The excavation cost of
$15,660 is a cost related to the build-ing, not to the acquisition of the land, as the excavation cost is
directly related to building the building on the land. So, the Wilson Co should record the cost of land
at $1,480,320
Question:
6. How does GAAP recommend accounting for interest costs in-curred during construction?
Answer:
Using this approach ignores the implicit interest cost associ-ated with the use of the cash. GAAP
requires only the actual interest costs incurred during construction be capitalized. This method
follows the historical cost principle. So you should capitalize the actual interest cost for the period
incurred during the period.
Question:
7. What assets qualify for interest cost capitalization?
Answer:
For the purposes of interest cost capitalization, qualifying assets must require a period of time to get
the asset ready for their intended purposes. Assets that do not qualify include assets that are currently
in use, assets that are ready for their intended use, or assets that are not in use due to excess capacity
or obsolescence. So, assets that are under construction for a company's own use.
Question:
8. When computing the amount of interest cost to be capital-ized, What does the concept of
"avoidable interest" refer to?
Answer:
Avoidable interest is the amount of interest cost during the period that a company could theoretically
avoid if it had not made the decision to purchase the asset in the first place. So, avoidable interest
refers to that portion of total interest cost which would not have been incurred if expenditures for
asset construction had not been made
Question:
9. What best describes the correct treatment of the interest costs capitalized during the period of
construction when a company purchases land as a site for a plant?
