Question

During 2017, Barden Building Company constructed own equipment at a total cost of $16,650,000.

Date	Capitalization Expenditure	Period	The weighted average accumulated expenditures
1-Apr	$5,000,000
1-Jun	$7,000,000
31-Aug	$3,650,000
31-Dec	$1,000,000
Total	$16,650,000

The company had the following debt outstanding at December 31, 2017:

1.   10%, 5-year note to finance construction of various assets,

      dated April 1, 2017, with interest payable annually on January 1                                    $6,300,000

2.   13.5%, ten-year bonds issued at par on December 31, 2011, with interest

      payable annually on December 31                                                                                  7,000,000

3.   9%, 3-year note payable, dated January 1, 2016, with interest payable

      annually on January 1                                                                                                    3,500,000

Compute the amounts of each of the following (show computations). Extra 1 point for being the first group, which provided correct answers

1. What is Actual Interest in 2017?_________________

2. What is Weighted average accumulated expenditures on assets?________________

3. What is Avoidable interest in 2017?______________________

4. Total interest to be capitalized during 2017____________

5. Record journal entries for asset capitalization in 2017

Extra 0.5 points: You are the first year auditor, who is doing company’s PPE analysis. You found out that the company did not capitalize interest in 2017 and therefore equipment depreciation expense was misstated in 2018. Please, write down ADJUSTMENT journal entry, that you will submit to your senior associate, to CORRECT depreciation expense in 2018, assuming that you agree with company’s estimates for salvage value: 1,000,000 and period of usage 10 years. Company applies straight-line depreciation method

Answer 1

1. Actual Interest is the Total Interest that the company needs to pay-

Particulars	Explanation	Amount(in $)
Specific Debt:
Interest for 10%, 5-year note to finance construction of various assets taken on April 1	$6,300,000*10%*9/12	472,500
Other debt:
13.5%, ten-year bonds issued Dec 31 , 2011	$7,000,000*13.5%	945,000
9%, 3-year note payable, dated January 1, 2016,	$3,500,000*9%	315,000
Total		1,732,500

2.Weighted average accumulated expenditures on assets

Date	capitalization expenditure (in $)	period	weighted average accumulated expenditure(WAAE)
Apr 1	5,000,000	9/12	5,000,000*9/12=3,750,000
Jun 1	7,000,000	7/12	7,000,000*7/12=4,083,333
Aug 31	3,650,000	4/12	3,650,000*4/12=1,216,667
Dec 31	1,000,000	0
	Total		9,050,000

3.What is Avoidable interest in 2017

Weighted avergae Interest rate for other Debts=$(945,000+315,000)/$(7,000,000+3,500,000)=12%

Calculation of avoidable Interest

WAAE	Avoidable Interest(in $)
Specific Debt loan of $6,300,000 @ 10%	472,500
Remaining $2,750,000@12%(9,050,000-6,300,000)	247,500
Total	720,000

4.Total interest to be capitalized during 2017

Interest cost that needs to be capitalized is the lesser of Avoidable Interest and Actual Interest i.e. lesser of $720,000 or $1,732,500.

Hence the answer is $720,000 i.e. the avoidable interest.

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