Question

On December 31, 2009, Hurston Inc. borrowed $900,000 at 12% payable annually to finance the construction of a new building. In 2010, the company made the following expenditures related to this building: March 1st, $360,000; July 1st, $1,600,000; December 1st, $1,200,000. Additional information is provided as follows. Other debt outstanding 10-year, 12% bond, December 31, 2003, interest payable annually $2,000,000 6-year, 10% note, dated December 31, 2007, interest payable annually $4,000,000

What is the weighted average accumulated expenditure?

What is the avoidable interest?

All interest are paid in cash on December 31^st. Prepare the journal entry to record cash payment of interest, the capitalization of interest and the recognition of interest expense, if any, at December 31, 2010.

Answer 1

Following schedule calculates the weighted average accumulated expenditures:
Payment Date	Expenditures	Capitalization Period	Weight	Weighted Expenditures
	(A)	(B)	(C=B/12)	(A×C)
1-Mar-10	$      360,000.00	10 Months	0.833333333	$                           300,000.00
1-Jul-10	$ 1,600,000.00	6 Months	0.5	$                           800,000.00
1-Dec-10	$ 1,200,000.00	1 Month	0.083333333	$                           100,000.00
Weighted Average Accumulated expenditure	$                       1,200,000.00
Out of this $1.2 million, $0.9 million is financed by specific loan. The rest i.e. $300,000 is financed out of the general loans. The interest rate on specific loan is 12% while the weighted interest rate on the general loans is calculated below.
Loan	Principal	Rate	Annual interest
10 year, 12% bond	$ 2,000,000.00	12%	$              240,000.00
6 year, 10% note	$ 4,000,000.00	10%	$              400,000.00
	$ 6,000,000.00		$              640,000.00
Weighted Average Interest Rate ($640,000/$6,000,000)	10.67%
The above calculations furnish us with all the data needed to arrive at an estimate of avoidable interest.
Funding	Amount	Rate	Avoidable Interest
Specific Loan	$      900,000.00	12%	$              108,000.00
General Loans	$      300,000.00	10.67%	$                32,000.00
			$              140,000.00
This $140,000 is the amount of interest that could have been avoided. This much interest can be capitalized provided it doesn’t exceed the actual interest expense for the period.
Houston Inc. should pass the following journal entry
Interest Expense ($640,000-$32,000) Dr	$                      608,000.00
Building                                                          Dr	$                      140,000.00
To Bank			$              748,000.00