Question

Hank Construction Company is building a hotel for speculative purposes. Hank Company has not found a buyer for the hotel, but expects to do so within a few months. Hank Construction Company expects to spend about another two years to complete construction of the hotel. Hank would like to know if interest and property taxes associated with construction should be capitalized or expensed. In addition, what interest rate, if any, should be used to capitalize interest costs?

Question to be answered: In a minimum of five to seven sentences, identify the key terms in your case and state why you believe that each one is relevant to your case.

Answer 1

The key terms in this case include capitalization, interest costs, property taxes, speculative purposes, and interest rate for capitalization. These terms are relevant as they guide the accounting decisions related to the construction project and its impact on the company's financial statements.

In the given scenario involving Hank Construction Company building a hotel for speculative purposes, several key terms are relevant:

Capitalization: This term is crucial as it refers to the accounting treatment of certain costs associated with the construction project. Capitalization involves recognizing certain costs as assets on the balance sheet rather than immediately expensing them. In this case, determining whether interest and property taxes should be capitalized or expensed is a critical decision.

Interest Costs: Given that the construction of the hotel is expected to take two more years, interest costs associated with financing the project need to be considered. The question is whether these interest costs should be capitalized, meaning added to the cost of the hotel, or expensed as incurred.

Property Taxes: Similar to interest costs, property taxes incurred during the construction period need to be assessed for proper accounting treatment. Deciding whether to capitalize or expense property taxes depends on accounting standards and the company's specific circumstances.

Speculative Purposes: This term implies that the hotel is being built without a confirmed buyer. The speculative nature of the project may influence the accounting treatment of certain costs, as the company may not yet have a definitive revenue stream to match against expenses.

Interest Rate for Capitalization: If interest costs are to be capitalized, determining the appropriate interest rate is crucial. The interest rate used for capitalization is typically the weighted average cost of capital (WACC) or a specific rate incurred on borrowed funds directly related to the construction project.

These key terms are relevant because they guide the company in making informed accounting decisions that align with generally accepted accounting principles (GAAP) and provide a clear financial picture of the construction project's impact on the company's books. The choices made in capitalizing or expensing certain costs can significantly influence financial statements and, consequently, affect stakeholders' understanding of the company's financial health and performance.

Answer 2

The key terms in the case would include factors like speculative purposes, capitalization, interest costs, and property taxes.

Why the terms are relevant to the case

The fact that the hotel is being built for speculative purposes is relevant because it affects the company's expectations about the future value of the hotel.

If the company expects to sell the hotel at a profit, then it is more likely to capitalize on interest and property taxes, as these costs will be recovered in the future.

Capitalization is relevant to the case because it determines whether interest and property taxes will be treated as an asset or an expense. If they are capitalized, they will be added to the cost of the hotel and will be amortized over the useful life of the asset but if they are expensed, they will be recognized as an expense in the current period and will reduce the company's net income.