Question

During 2020, Barden Building Company constructed various assets at a total cost of $14,700,000. The weighted average accumulated expenditures on assets qualifying for capitalization of interest during 2020 were $9,800,000. The company had the following debt outstanding at December 31, 2020:

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

      dated January 1, 2020, with interest payable annually on January 1                     $6,300,000

2.   12%, ten-year bonds issued at par on December 31, 2014, with interest

      payable annually on December 31                                                                            7,000,000

3.   9%, 3-year note payable, dated January 1, 2019, with interest payable

      annually on January 1                                                                                               3,500,000

Instructions - Compute the amounts of each of the following (show computations).

1. Avoidable interest.

2. Total interest to be capitalized during 2020.

Answer 1

1) Avoidable interest = $1,015,000

Explanation:-

Weighted average accumulated expenditures	Applicable interest rate	Avoidable interest
$6,300,000	10%	$630,000
$3,500,000 ($9,800,000 - $6,300,000)	11%(see note-1)	$385,000
$9,800,000		$1,015,000
Note:- 1) Computation of weighted average interest rate:
	Principal	Interest
12% ten - year bonds	$7,000,000	$840,000 ($7,000,000 ×12%)
9% 3 - year note payable	$3,500,000	$315,000 ($3,500,000 × 9%)
	$10,500,000	$1,155,000
Weighted average interest rate = $10,500,000 / $1,155,000 = 11%

2) Total interest to be capitalized during 2020= $1,015,000

Explanation:-

Actual interest cost during 2020:
Construction note ($6,300,000 ×10%)	$630,000
12% ten - year bonds ($7,000,000 ×12%)	$840,000
9% 3- year note payable ($3,500,000 ×9%)	$315,000
	$1,785,000

The interest cost to be capitalized is $1,015,000 ( the lesser of the $1,015,000 avoidable interest and the $1,785,000 actual interest)

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