Question

Interest during construction

Jones company is constructing a production complex that qualifies for interest capitalization. The following information is available:

• capitalization period: January 1, 2016 to June 30, 2017

• expenditures on project

2016:

January 1-$468,000

May 1-$489,000

October 1-$648,000

2017

March 1-$1,452,000

June 30-$588,000

• amounts borrowed and outstanding:

$1.4 million borrowed at 10%, specifically for the project

$7 million borrowed on July 1, 2105, at 12%

$19 million borrowed on January 1, 2011, at 6%

Required:

Note: round all final numeric answers to the nearest dollar

1. Computer amount of interest cost capitalized each year

Capitalized interest, 2016. ___________

Capitalize interest 2017. ______________

2. If it is assumed that the production complex has an estimated life of 20 years and a residual value of $0, compute the straight-line depreciation in 2017. __________________

Answer 1

1	Inteterst to be capitalized in 2016:
	Weighted average accumulated expenditure:
			Amount	Months	Weighted Average expenses
	Jan 1.Expenses		468000	12	(468000*12/12)=468000
	May 1.Expenses		489000	8	(489000*8/12)=326000
	Oct 1.Expenses		648000	3	(648000*3/12)=162000
	Total					956000
	Month is calculated from the date of expenditure incurred till Dec 31.
	Avoidable interest
				Amount of loan	Interest %	Avoidable Interest
				1	2	1*2
	Specific debt			1400000	10%	140000
	General debt			956000	7.62%	72847
					(Note:1)
	Total avoidable interest					212847
	Weighted average interest rate for general debt:
				Amount of loan	Interest %	Interest
	12% loan			7000000	12%	840000
	6% loan			19000000	6%	1140000
				26000000		1980000
	Weighted average interest rate=Total interest expenses/Total amount of loan=1980000/26000000=0.0762=7.62%
	Actual interest:
				Amount of loan	Interest %	Actual interest
				1	2	1*2
	Specific debt			1400000	10%	140000
	General debt
	12% loan			7000000	12%	840000
	6% loan			19000000	6%	1140000
	Total actual interest					2120000
	Since total avoidable interest is less than actual interest,Interest to be capitalized=Avoidable interest=$212847
	Inteterst to be capitalized in 2017:
	Weighted average accumulated expenditure:
			Amount	Months	Weighted Average expenses
	Mar 1.Expenses		1452000	4	(1452000*4/6)=968000
	June 30.Expenses		588000	0	(588000*0/6)=0
	Total					968000
	Month is calculated from the date of expenditure incurred till June 30.
	Avoidable interest
				Amount of loan	Interest %	Avoidable Interest
				1	2	1*2
	Specific debt			1400000	10%	140000
	General debt			968000	3.80%	36784
					(Note:1)
	Total avoidable interest					176784
	Weighted average interest rate for general debt:
				Amount of loan	Interest %	Interest For 6 months
	12% loan			7000000	12%	420000
	6% loan			19000000	6%	570000
				26000000		990000
	Weighted average interest rate=Total interest expenses/Total amount of loan=990000/26000000=0.0380=3.80%
	Actual interest:
				Amount of loan	Interest %	Actual interest for 6 months
				1	2	1*2
	Specific debt			1400000	10%	70000
	General debt
	12% loan			7000000	12%	420000
	6% loan			19000000	6%	570000
	Total actual interest					1060000
	Since total avoidable interest is less than actual interest,Interest to be capitalized=Avoidable interest=$176784
2	Total cost of production complex:
	2016 expenses
	Jan 1.			468000
	May 1.			489000
	Oct 1.			648000
	Interest capitalized			212847
	2017 expenses
	Mar 1.			1452000
	June 30.			588000
	Interest capitalized			176784
	Total			4034631
	Straight line depreciation=(Cost-Salvage value)/Useful life=(4034631-0)/20=$ 201731.60