Question

On January 1, 2015, Toby Manufacturing Company began construction of a building to be used as its second office. The building is completed on August 31, 2016. Expenditures on the project were as follows:

January 3, 2015 $900,000

March 1, 2015 600,000

June 30, 2015 700,000

November 1, 2015 600,000

January 31, 2016 800,000

April 30, 2016 900,000

August 31, 2016 675,000

In order to finance the project, the company obtained a $2 million loan with a 10% interest on January 1, 2015. The principal of the loan will be paid off at the end of 2016. The company’s other interest-bearing debt includes two long-term notes of $5,000,000 and $7,000,000 with interest rates of 6% and 9%, respectively. Both notes are outstanding during all of 2015 and 2015. The company’s fiscal year-end is December 31.

Required: 1. Calculate the amount of interest that Toby should capitalize in 2015 and 2016 using the specific interest method. 2. Calculate interest expense that will appear in the 2015 and 2016 income statements. 3. What is the total cost of the building?

Answer 1

Solution:

1.

Date Of expenditure	Amount of expenditure
3-Jan-2015	9,00,000
1-Mar-2015	6,00,000
30-Jun-2015	7,00,000
1-Nov-2015	6,00,000
31-Jan-2016	8,00,000
30-Apr-2016	9,00,000
31-Aug-2016	6,75,000
	Amount	Interest
Specific Borrowing	20,00,000	10%
Other Borrowing 1	50,00,000	6%
Other Borrowing 2	70,00,000	9%
Step 1:	Weighted average Accumulated Expenses
900000 X 12/12	9,00,000
600000 X 10/12	5,00,000
700000 X 6/12	3,50,000
600000 X 2/12	1,00,000
Total	18,50,000
Interest to be capitalized in 2015	1850000 X 10%
i.e.	1,85,000
Interest to be capitalized in 2016
	Weighted average Accumulated Expenses
800000 X 7/12	4,66,667
900000 X 4/12	3,00,000
675000 X 0/12	-
Total	7,66,667
Interest to be capitalised
From Specific Borrowing	150000 X 10% X 8/12
i.e.	10,000	------(1)
From Other Borrowings
5000000 x 6%	3,00,000
7000000 x 9%	6,30,000
Total	9,30,000
Interest Rate	930000 x 100/(5000000+7000000)
i.e.	7.75
616667 X 7.75% X 8/12	31,861	------(2)
Total Interest to be capitalized	41,861	------(1)+(2)

2.	Interest expenses that appear in income statement in 2015
Total Interest
From Specific Borrowing	2000000 x 10%	2,00,000
From Other Borrowing	5000000 x 6% + 7000000 x 9%	9,30,000
Total Interest		11,30,000	-----(3)
Interest Capitalised during the year 2015		1,85,000	-----(4)
Interest showed in income statement in 2015 year		9,45,000	-----(3)-(4)
Since the principle amount is not repaid the amount of total interest in 2016 also remains the same
i.e.		11,30,000	-----(5)
Interest Capitalised during the year 2016		41,861	-----(6)
Interest showed in income statement in 2016 year		10,88,139	-----(5)-(6)

3.	Total Cost of building
Expenses incurred	900000+600000+700000+600000+800000+900000+675000
i.e.	51,75,000	-----(7)
Interest to be capitalized	185000+41861
i.e.	2,26,861	-----(8)
Total Building cost	54,01,861	-----(7)+(8)