Why Are the Costs of Buildings Different?
In FASB Statement No.34, the FASB called for the capitalization of interest costs associated with projects involving the construction or development of assets extending over a significant time period. Interest capitalized is restricted to the amount of interest actually incurred. Consider the case of the following two companies that both constructed a building with a total construction cost of $20 million but chose to finance the construction differently. The costs were incurred evenly over the course of a year; computationally, this is the same as assuming that the entire $20 million was paid halfway through the year.
|
|
Company A |
Company B |
|
Total construction cost of building (excluding interest) |
$20,000,000 |
$20,000,000 |
|
Company financing (outstanding at year end): |
|
|
|
Construction loan (14%) |
20,000,000 |
0 |
|
Common stock issue |
0 |
20,000,000 |
|
Total construction loan interest during the year |
|
|
|
(based on average outstanding loan balance) |
1,400,000 |
0 |
As the auditor for both companies, you are asked by your supervisor to prepare a report that calculates the total cost for each building that would be included in each company’s financial statements. Because both companies had the option of purchasing the buildings from a contractor rather than constructing them, your report should include your estimate of the price the contractor would have charged and how you explain the discrepancy in the way cost was determined for the two buildings. Conclude your report by proposing a change in the accounting standards that could eliminate this discrepancy.