Question

After being in business for 3 years, Franco Ltd. realised that its warehouse facility was inadequate. The company decided to construct a new building to expand its warehouse capabilities.

To finance this venture, Franco Ltd. acquired a loan of $2,000,000 on January 1, 2018, with an interest rate of 10% payable annually. Construction on the new building started on January 1, 2018 with a projected completion date of December 31, 2018.

During the year, the company’s expenditure schedule for the new building was as follows:

February 1, 2018: $960,000

May 31, 2018: $1,200,000

July 1, 2018: $750,000

September 30, 2018: $800,000

November 1, 2018: $720,000

The company had 2 other debts outstanding on January 1, 2018:

$3,000,000 8%, 7 year note, interest payable annually.

$1,500,000 12%, 10 year bond, interest payable per annum.

Franco Ltd. Financial year ends December 31.

Required:
a) Compute the following. Round interest rate percentages calculated to 1 decimal place.

i. Weighted Average Accumulated Expenditure (WAAE).

ii. Actual Interest.

iii. Avoidable interest.

b) What amount of interest should be capitalised in 2018 in relation to the construction of the building?

c) Prepare the journal entry to record capitalisation of interest and the recognition of interest expense, if any, at December 31, 2018.

Answer 1

Total Expeses = 4430000 Capitalsed Period e.g. 01 Feb 11 month 960000*11/12 = 880000/- same for all three it will come Rs 2275000/-

WAAE = 2275000

Actual Interest = 620000/6500000 = 9.54%

Avoidable Interest

Specific Debts = 2000000 Interest = 200000

Genereal Debts

Notes = 3000000 Interest = 240000

Bonds = 1500000 Interest = 180000

Weighted Avg Interest Rate of General Debts = 420000/4500000 = 9.33%

Specifica Debts 2000000 * 10% = 200000/-

General Debts   275000 * 9.33%   25658/-

Total Avoidable Interest = 225658

Interest to be Capitalised is Whicher is Lower :

a) Actual Interest = 620000

b) Avoidable Interest = 225658

Interest Capitalised = 225658/-

Jouranl Enteries

Building Account Dr    225658/-

To Interest Exp.             Cr                   225658/-

Interest Exp.       Dr              620000/-

To Specific / General Debts       Cr            620000/-