Question

During 2020, Maria Building Company constructed various assets at a total cost of $12,600,000. The weighted average accumulated expenditures on assets qualifying for capitalization of interest during 2020 were $8,347,000. 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		$5,388,000
2.		12%, ten-year bonds issued at par on December 31, 2014, with interest payable annually on December 31		5,811,000
3.		9%, 3-year note payable, dated January 1, 2019, with interest payable annually on January 1		2,905,500

Compute the amounts of each of the following.

1.	Avoidable interest		$
2.	Total interest to be capitalized during 2020

Answer 1

Answer:

1.	Avoidable interest	$ 864,290
2.	Total interest to be capitalized during 2020	$ 864,290

Calculation:

1. Avoidable interest

To calculate the avoidable interest first we need to calculate the average interest rate:

For that we need to take the principal amount of debt which is not dated 2020 and multiply with the interest rate.

So here we calculate the total of principal and total of interest.

	Principal	Interest
12% ten year bonds issued at par	5,811,000	697,320
9% 3-yeat note payable	2,905,500	261,495
	8,716,500	958,815

Then we need to calculate the average interest rate:

So the average interest rate will be = Interest / Principal = 958,815 / 8,716,500 = 11%

Then, we need to calculate the other loan amount.

Other loan amount = Weighted average accumulated expenditures on assets qualifying for capitalization of interest - Debt outstanding dated January 1, 2020 = 8,347,000 - 5,388,000 = 2,959,000

Now we can proceed with calculation of avoidable interest. For that we need to take Debt outstanding dated January 1, 2020  and multiply with the interest rate to get Interest on loan on finance construction of various assets. Then we need to add the Other loan amount multiplied with the average interest rate we calculated.

Calculation of avoidable interest:

	Amount	Rate	Avoidable Interest
Interest on loan on finance construction of various assets	5,388,000	10%	538,800
Add: Interest on other loan at average rate of interest	2,959,000	11%	325,490
Total	8,347,000		864,290

So the avoidable interest rate is 864,290.

2. Total interest to be capitalized during 2020

To calculate the Total interest to be capitalized during 2020, we need to calculate the actual interest cost:

For that we need to take all the debt outstandingand then multiply with the interest rate.

10%, 5-year note to finance construction of various assets, dated January 1, 2020, with interest payable annually on January 1 = 5,388,000 * 10% = 538,800

12%, ten-year bonds issued at par on December 31, 2014, with interest payable annually on December 31 = 5,811,000 * 12% = 697,320

9%, 3-year note payable, dated January 1, 2019, with interest payable annually on January 1 = 2,905,500 * 9% = 261,495

So the total actual interest is calculated as below:

10% 5 year note	538,800
12% ten year bond	697,320
9% 3 year notes payable	261,495
	1,497,615

The interest cost to be capitalized is the lesser of the avoidable interest and the actual interest. Here the avoidable interest is 864,290 and actual interest is 1,497,615. So, lesser of both is the avoidable interest of 864,290. Hence the Total interest to be capitalized during 2020 is 864,290