Choice "B" is correct. The amount capitalized as the cost of the equipment should include all amounts necessary to purchase the equipment, bring the equipment to the location and condition as necessary for its intended use. These costs will include the cash paid for the down payment, the present value of the note payable, the shipping charges, and the installation charges:
Down payment | $ 4,000 |
Present value of note payable | 15,480 | $6,000 x 2.58 |
Shipping charges | 2,000 |
Installation charges | 3,500 |
Cost of equipment | $24,980 |
All notes payable are required to be reported at the present value of the payments to be made, computed using the market rate of interest. This problem indicates that the company will make annual payments on the note of $6,000 and that the present value factor for 3 periods at 8% (the market rate) is 2.58, so the present value of the note payable is $15,480 ($6,000 x 2.58).Choice "d" is incorrect. This amount fails to include the shipping and installation charges. These charges are necessary to bring the equipment to the location and condition as necessary for its use and must be capitalized as part of the cost of the equipment.
Choice "c" is incorrect. This amount fails to include the installation charges. The installation charges are necessary to make the equipment ready for use and must be capitalized as part of the cost of the equipment.
Choice "a" is incorrect. This amount incorrectly includes the note payable at its face amount of $18,000, rather than at the present value of the annual payments, discounted using the 8% interest rate. All notes payable are required to be reported at the present value of the payments to be made computed using the market rate of interest. This problem indicates that the company will make annual payments on the note of $6,000 and that the present value factor for 3 periods at 8% (the market rate) is 2.58, so the present value of the note payable is $15,480 ($6,000 x 2.58). The fact that the present value of the note is less than the $18,000 face amount of the note and the statement that $6,000 is paid annually on the note (rather than $6,000 plus accrued interest) implies that this note payable is a non-interest bearing note.
