Question

Problem 10-9 Interest capitalization; specific interest method [LO10-7]

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	$	1,420,000
March 1, 2018		1,140,000
June 30, 2018		1,340,000
October 1, 2018		1,140,000
January 31, 2019		351,000
April 30, 2019		684,000
August 31, 2019		981,000

On January 1, 2018, the company obtained a $3,900,000 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 $6,000,000 and $9,000,000 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

Expenditure for 2018
January 1, 2018	1420000	* 12/12	1420000
March 1, 2018	1140000	* 10/12	950000
June 30, 2018	1340000	* 6/ 12	670000
October 1, 2018	1140000	* 3/12	285000
Accumulated expenditures	5040000
Before interest
Average Accumulated expenditures			3325000

Interest capitalized:$3,325,000 x 12% = $399,000 = Interest capitalized in 2018

Expenditure for 2019
January 1, 2019	5439000	* 9/9	5439000
January 31, 2019	351000	* 8/9	312000
April 30, 2019	684000	* 5/9	380000
August 31, 2019	981000	* 1/9	109000
Accumulated expenditures	7455000
Before interest
Average Accumulated expenditures			6240000

Weighted-average rate of all other debt

$6,000,000 * 8% = $ 480,000

$9,000,000 * 10% = $ 900,000

Weighted Average = 1380000 / 15,000,000 = 9.2%

Interest capitalized:

$3,900,000 * 12% x 9/12 = $351,000

2,340,000 x 9.2% x 9/12 = 161,460

Total = 512460 Interest capitalized in 2019

Cost of Building:

Expenditures in 2018= $3,325,000

Interest capitalized in 2018: 399,000

Expenditures in 2019: 2,016,000

Interest capitalized in 2019 : 512,460

Total cost of building $ 6252460

Interest Expense for 2018:

$3,900,000 x 12% =$ 468,000

6,000,000 x 8% = 480,000

9,000,000 x 10% =900,000

Total interest incurred 1,779,000

Less: Capitalized (399,000)

2018 expense $ 1,449,000

Interest Expense for 2019:

Total interest incurred $1,779,000

Less: Capitalized (512,460)

2019 expense $ 1,266,540