(LO 1) Darby Sporting Goods Inc. has been experiencing growth inthe demand for its products over the last several years. The lasttwo Olympic Games greatly increased the popularity of basketballaround the world. As a result, a European sports retailingconsortium entered into an agreement with Darby's RoundballDivision to purchase basketballs and other accessories on anincreasing basis over the next 5 years.
To be able to meet the quantity commitments of this agreement,Darby had to obtain additional manufacturing capacity. A realestate firm located an available factory in close proximity toDarby's Roundball manufacturing facility, and Darby agreed topurchase the factory and used machinery from Encino AthleticEquipment Company on October 1, 2016. Renovations were necessary toconvert the factory for Darby's manufacturing use.
The terms of the agreement required Darby to pay Encino $50,000when renovations started on January 1, 2017, with the balance to bepaid as renovations were completed. The overall purchase price forthe factory and machinery was $400,000. The building renovationswere contracted to Malone Construction at $100,000. The paymentsmade, as renovations progressed during 2017, are shown below. Thefactory was placed in service on January 1, 2018.
1/1
4/1
10/1
12/31
Encino
$50,000
$90,000
$110,000
$150,000
Malone
â30,000
ââ30,000
ââ40,000
On January 1, 2017, Darby secured a $500,000 line-of-credit witha 12% interest rate to finance the purchase cost of the factory andmachinery, and the renovation costs. Darby drew down on theline-of-credit to meet the payment schedule shown above; this wasDarby's only outstanding loan during 2017.
Bob Sprague, Darby's controller, will capitalize the maximumallowable interest costs for this project. Darby's policy regardingpurchases of this nature is to use the appraisal value of the landfor book purposes and prorate the balance of the purchase priceover the remaining items. The building had originally cost Encino$300,000 and had a net book value of $50,000, while the machineryoriginally cost $125,000 and had a net book value of $40,000 on thedate of sale. The land was recorded on Encino's books at $40,000.An appraisal, conducted by independent appraisers at the time ofacquisition, valued the land at $290,000, the building at $105,000,and the machinery at $45,000.
Angie Justice, chief engineer, estimated that the renovatedplant would be used for 15 years, with an estimated salvage valueof $30,000. Justice estimated that the productive machinery wouldhave a remaining useful life of 5 years and a salvage value of$3,000. Darby's depreciation policy specifies the 200%declining-balance method for machinery and the 150%declining-balance method for the plant. One-half year'sdepreciation is taken in the year the plant is placed in service,and one-half year is allowed when the property is disposed of orretired. Darby uses a 360-day year for calculating interestcosts.
Instructions
(a) Determine the amounts to be recorded on the booksof Darby Sporting Goods Inc. as of December 31, 2017, for each ofthe following properties acquired from Encino Athletic EquipmentCompany.
1.Land.
2.Buildings.
3.Machinery.
(b)
Calculate Darby Sporting Goods Inc.'s 2018 depreciation expense,for book purposes, for each of the properties acquired from EncinoAthletic Equipment Company.
(c)
Discuss the arguments for and against the capitalization ofinterest costs
(LO 1) Darby Sporting Goods Inc. has been experiencing growth inthe demand for its products over the last several years. The lasttwo Olympic Games greatly increased the popularity of basketballaround the world. As a result, a European sports retailingconsortium entered into an agreement with Darby's RoundballDivision to purchase basketballs and other accessories on anincreasing basis over the next 5 years.
To be able to meet the quantity commitments of this agreement,Darby had to obtain additional manufacturing capacity. A realestate firm located an available factory in close proximity toDarby's Roundball manufacturing facility, and Darby agreed topurchase the factory and used machinery from Encino AthleticEquipment Company on October 1, 2016. Renovations were necessary toconvert the factory for Darby's manufacturing use.
The terms of the agreement required Darby to pay Encino $50,000when renovations started on January 1, 2017, with the balance to bepaid as renovations were completed. The overall purchase price forthe factory and machinery was $400,000. The building renovationswere contracted to Malone Construction at $100,000. The paymentsmade, as renovations progressed during 2017, are shown below. Thefactory was placed in service on January 1, 2018.
1/1 | 4/1 | 10/1 | 12/31 | |
Encino | $50,000 | $90,000 | $110,000 | $150,000 |
Malone | â30,000 | ââ30,000 | ââ40,000 |
On January 1, 2017, Darby secured a $500,000 line-of-credit witha 12% interest rate to finance the purchase cost of the factory andmachinery, and the renovation costs. Darby drew down on theline-of-credit to meet the payment schedule shown above; this wasDarby's only outstanding loan during 2017.
Bob Sprague, Darby's controller, will capitalize the maximumallowable interest costs for this project. Darby's policy regardingpurchases of this nature is to use the appraisal value of the landfor book purposes and prorate the balance of the purchase priceover the remaining items. The building had originally cost Encino$300,000 and had a net book value of $50,000, while the machineryoriginally cost $125,000 and had a net book value of $40,000 on thedate of sale. The land was recorded on Encino's books at $40,000.An appraisal, conducted by independent appraisers at the time ofacquisition, valued the land at $290,000, the building at $105,000,and the machinery at $45,000.
Angie Justice, chief engineer, estimated that the renovatedplant would be used for 15 years, with an estimated salvage valueof $30,000. Justice estimated that the productive machinery wouldhave a remaining useful life of 5 years and a salvage value of$3,000. Darby's depreciation policy specifies the 200%declining-balance method for machinery and the 150%declining-balance method for the plant. One-half year'sdepreciation is taken in the year the plant is placed in service,and one-half year is allowed when the property is disposed of orretired. Darby uses a 360-day year for calculating interestcosts.
Instructions
(a) Determine the amounts to be recorded on the booksof Darby Sporting Goods Inc. as of December 31, 2017, for each ofthe following properties acquired from Encino Athletic EquipmentCompany.
1.Land.
2.Buildings.
3.Machinery.
(b)
Calculate Darby Sporting Goods Inc.'s 2018 depreciation expense,for book purposes, for each of the properties acquired from EncinoAthletic Equipment Company.
(c)
Discuss the arguments for and against the capitalization ofinterest costs
