Question

On January 1, 2018, the Mason Manufacturing Company began construction of a building to be used as its office headquarters. The building was completed on September 30, 2019.

Expenditures on the project were as follows:

January 1, 2018	$	1,200,000
March 1, 2018		900,000
June 30, 2018		1,100,000
October 1, 2018		900,000
January 31, 2019		315,000
April 30, 2019		648,000
August 31, 2019		945,000

On January 1, 2018, the company obtained a $3,500,000 construction loan with a 12% interest rate. The loan was outstanding all of 2018 and 2019. The company’s other interest-bearing debt included two long-term notes of $3,000,000 and $7,000,000 with interest rates of 8% and 10%, respectively. Both notes were outstanding during all of 2018 and 2019. Interest is paid annually on all debt. The company’s fiscal year-end is December 31.

Required:
1. Calculate the amount of interest that Mason should capitalize in 2018 and 2019 using the specific interest method.
2. What is the total cost of the building?
3. Calculate the amount of interest expense that will appear in the 2018 and 2019 income statements.
  

Answer 1

1.

Expenditures For 2018

                January 1, 2018                 ($1,200,000 * 12/12)       = $1,200,000

                March 1, 2018                    ($900,000 * 10/12)           = $750,000

                June 30, 2018                     ($1,100,000 * 6/12)          = $550,000

                October 1, 2018 ($900,000 * 3/12)             = $225,000

                Accumulated Expenditure (before Interest)        = $4,100,000

                Average Accumulated Expenditure                         = $2,725,000

Interest Capitalization for 2018

                Average Accumulated Expenditure         = $2,725,000

                Interest rate on loan is 12%

                Interest Capitalization = ($2,725,000 * 12%) = $327,000

Expenditures For 2019

January 1, 2019 ($3,500,000 + $327,000) * 9/9 = $3,827,000

January 31, 2019               ($315,000 * 8/9) = $280,000

April 30, 2019                     ($648,000 * 5/9) = $360,000

August 31, 2019 ($945,000 * 1/9) = $105,000

Accumulated Expenditure                           = $5,735,000

                Average Accumulated Expenditure         = $4,572,000

Interest Capitalization for 2019

($3,500,000) * 12% * 9/12             = $315,000

($1,072,000) * 9.4% * 9/12           = $75,576

Interest Capitalized in 2019        = $390,576

Weighted average rate of all other debt –

                $3,000,000 * 8% = $240,000

                $7,000,000 * 10% = $700,000

                                Rate = $940,000 / 10,000,000 = 9.4% or 0.094

2.

                Accumulated Expenditures 9/30/2019    = $5,735,000

                2019 Interest capitalization                          = $390,576

                Total Cost of Buildings                                  = $ 6,125,576

3.

                Part 1 – 2018

                $3,500,000 * 12%              = $420,000

                $3,000,000 * 8%                = $240,000

                $7,000,000 * 10%              = $700,000

                Total Interest Incurred = $1,360,000

                Less – Interest Capitalized = ($327,000)

                2018 Interest Expenses = $1,033,000

                Part 2 – 2019

                Total Interest Incurred = $1,360,000

                Less – Interest Capitalized = ($390,576)

                2019 Interest Expenses = $969,424