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	$	1,820,000
March 1, 2018		1,440,000
June 30, 2018		1,640,000
October 1, 2018		1,440,000
January 31, 2019		396,000
April 30, 2019		729,000
August 31, 2019		1,026,000

On January 1, 2018, the company obtained a $4,400,000 construction loan with a 14% interest rate. The loan was outstanding all of 2018 and 2019. The company’s other interest-bearing debt included two long-term notes of $2,000,000 and $8,000,000 with interest rates of 10% and 12%, 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

Solution:

Average interest rate = (2 x 10% + 8 x 12%) / (2+ 8)

=116 % / 10

= 11.6%

Average expenditure during 2018

Jan 1 $1,820,000 x 12/12 = $1,820,000

Mar 1 $1,440,000 x 10/12 = $1,200,000

June 30 $1,640,000 x 6/12 = $820,000

Oct 1 $1,440,000 x 3/12 = $360,000

  Total    = $4,200,000

Average expenditure during 2019

$6,340,000 x 12/12 = $6,340,000

Jan 31 $396,000 x 11/12 = $363,000

Apr 30 $729,000 x 8/12 = $486,000

Aug 31 $1,026,000 x 4/12 = $342,000

Total = $7,531,000

(1) capitalize in 2018

weighted-average expenditure	Interest rate	Interest capitalized
$4,200,000	14%	$588,000

capitalize in 2019

weighted-average expenditur	interest rate	interest
$4,400,000	14%	$616,000
$3,131,000	11.6%	$363,196
$7,531,000	Total	$979,196

(2) total cost of the building = total expenditure + interest capitalized

= $8,491,000 + $588,000+ $979,196

= $10,058,196

(3) Total interest = $4,400,000 x 14% + $2,000,000 x 10% + $8,000,000 x 12%

= $616,000 + $200,000 + $960,000

= $1,776,000

	2018	2019
Total interest	$1,776,000	$1,776,000
Less: Interest Capitalized	$588,000	$979,196
interest expense that will appear in income statements	$1,188,000	$796,804