Question

On January 1, 2018, the Mason Manufacturing Company began construction of a building to be used as its office headquarters. The building was completed on September 30, 2019.

Expenditures on the project were as follows:

January 1, 2018	$	1,000,000
March 1, 2018		600,000
June 30, 2018		800,000
October 1, 2018		600,000
January 31, 2019		270,000
April 30, 2019		585,000
August 31, 2019		900,000

On January 1, 2018, the company obtained a $3 million construction loan with a 10% interest rate. The loan was outstanding all of 2018 and 2019. The company’s other interest-bearing debt included two long-term notes of $4,000,000 and $6,000,000 with interest rates of 6% and 8%, respectively. Both notes were outstanding during all of 2018 and 2019. Interest is paid annually on all debt. The company’s fiscal year-end is December 31.

Required:
1. Calculate the amount of interest that Mason should capitalize in 2018 and 2019 using the specific interest method.
2. What is the total cost of the building?
3. Calculate the amount of interest expense that will appear in the 2018 and 2019 income statements.

Answer 1

1) Interest Capitalized in 2018 = $205,000

Interest Capitalized in 2019 = $271,980

Calculation:-

Expenditure for 2018:-

January 1, 2018	1,000,000 × 12/12	$1,000,000
March 1, 2018	6,00,000 × 10/12	$5,00,000
June 30, 2018	8,00,000 × 6/12	$4,00,000
October 1, 2018	6,00,000 × 3/12	$150,000
		$2,050,000

Interest Capitalized:-

$2,050,000 × 10% = $205,000 =Interest Capitalized in 2018

Expenditure for 2019:-

January 1, 2019 (3,000,000 + 205,000)	3,205,000 × 9/9	$3,205,000
January 31, 2019	270,000 × 8/9	240,000
April 30 , 2019	585,000 × 5/9	325,000
August 31, 2019	900,000 × 1/9	1,00,000
	$4,960,000	$3,870,000

As construction is completed on September 30, 2019( thats why 9 months is taken)

Interest Capitalized:-

$3,000,000 × 10% ×9/12	$225,000
(3,870,000 - 3,000,000) × 7.2% ×9/12	46,980
Interest Capitalized in 2019	$271,980

Note:- $3,000,000 (construction loan)

Weighted average rate of all other debt:-

$4,000,000 ×6%	$240,000
$6,000,000 ×8%	480,000
$10,000,000	$720,000

= $720,000/10,000,000 = 7.2%

2)

Accumulated expenditure on 30/09/2019 before interest Capitalized(above)	$4,960,000
2019 interest Capitalized	$271,980
Total cost of buildings	$5,231,980

3)

$3,000,000 × 10%	$3,00,000
$4,000,000 × 6%	$240,000
$6,000,000 × 8%	$480,000
	$1,020,000

Interest expense for 2018 =

Total interest incurred	$1,020,000
Less: interest Capitalized	($205,000)
2018 interest expense	$815,000

Interest expense for 2019=

Total interest incurred	$1,020,000
Less: interest Capitalized	($271,980)
2019 interest expense	$748,020