Question

On December 31, 2012, Cia Company borrowed $400,000 from First Bank with interest payable annually at 10% maturing on December 31, 2015 in order to provide funds for the construction of a building to use as its corporate headquarters. On January 1, 2013, Cia Company started the construction. The project was completed and ready for occupancy on December 31, 2013. Cia incurred the following expenditures related to construction during 2013:

January 1	$400,000
April 1	350,000
October 31	900,000
December 31	250,000
	$1,900,000

Aside from the loan described above, Cia also had a $1,000,000 5-year note payable issued December 31, 2012 that bears interest annually at 8% and $1,200,000 of bonds payable issued on December 31, 2010 due in 10 years that bear interest annually at 9%.

1. Compute weighted average accumulated expenditures for the construction project.

2. Compute Actual Interest and Avoidable Interest for the project for 2013. (Hint: you will also need to calculate a weighted average interest rate on Cia’s general debt.

Answer 1

Compute total weighted average accumulated expenditures as follows:

Date	Expenditures	×	Portion of Year Outstanding	=	Weighted Average Accumulated Expenditures
January 1	$400,000	×	12 ÷ 12	=	$400,000
April 1	$350,000	×	9 ÷ 12	=	$262,500
October 31	$900,000	×	2 ÷ 12	=	$150,000
December 31	$250,000	×	0 ÷ 12	=	0
	$1,900,000				$812,500

Compute avoidable interest as follows

Particulars	Amount	×	Rate	=	Interest
Construction Loan	$400,000	×	10.00%	=	$40,000
Internal funds ($812,500 − $400,000)	$412,500	×	8.55%	=	$35,269
Total avoidable interest					$75,269

Note: Compute weighted average interest rate as follows

Weighted average interest on general debt = 8.55% ($188,000 ÷ $2,200,000)

Particulars	Amount	×	Rate	=	Interest
8% Note Payable	$1,000,000	×	8.00%	=	$80,000
9% Bonds Payable	$1,200,000	×	9.00%	=	$108,000
Total	$2,200,000				$188,000

Compute actual interest as follows:   

Particulars	Amount	×	Rate	=	Interest
Construction Loan	$400,000	×	10%	=	$40,000
8% Note Payable	$1,000,000	×	8%	=	$80,000
9% Bonds Payable	$1,200,000	×	9%	=	$108,000
Total actual interest					$228,000