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 - $ 1,360,000

March 1, 2018 - 810,000

June 30, 2018 - 160,000

October 1, 2018 - 670,000

January 31, 2019 - 585,000

April 30, 2019 - 900,000

August 31, 2019 - 1,530,000

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 $4,700,000 and $6,700,000 with interest rates of 7% and 9%, 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 weighted-average 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 = (4.7 x 7% + 6.7x 9%) / (4.7+ 6.7)

= 93.2 % / 11.4

= 8.17%

Average expenditure during 2018

Jan 1 $1,360,000 x 12/12 = $1,360,000

Mar 1 $810,000 x 10/12 = $675,000

June 30 $160,000 x 6/12 = $80,000

Oct 1 $670,000 x 3/12 = $167,500

  Total    = $2,282,500

Average expenditure during 2019

$3,000,000 x 12/12 = $3,000,000

Jan 31 $585,000 x 11/12 = $536,250

Apr 30 $900,000 x 8/12 = $600,000

Aug 31 $1,530,000 x 4/12 = $510,000

Total = $4,646,250

(1) capitalize in 2018

weighted-average expenditure	Interest rate	Interest capitalized
$2.282,500	10%	$228,250

capitalize in 2019

weighted-average expenditur	interest rate	interest
$3,000,000	10%	$300,000
$646,250	8.17%	$52,799
		$352,799

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

= $6,015,000 + $228,250+ $352,799

= $6,596,049

(3) Total interest = $3,000,000 x 10% + $4,700,000 x 7% + $6,700,000 x 9%

= $300,000 + $329,000 + $603,000

= $1,232,000

	2018	2019
Total interest	$1,232,000	$1,232,000
Less: Interest Capitalized	$228,250	$352,799
interest expense that will appear in income statements	$1,003,750	$879,201