Question

Red Man Construction is constructing a building. Construction began on January 1 and was completed on December 31. Expenditures were $6,400,000 on March 1, $5,280,000 on June 1, and $8,000,000 on December 31. Red Man borrowed $3,200,000 on January 1 on a 5-year, 12% note to help finance construction of the building. In addition, the company had outstanding all year a 10%, 3-year, $6,400,000 note payable and an 11%, 4-year, $12,000,000 note payable. what amount of interest should be charged to expense?

Answer 1

	Actual interest expenditure incurred:
				Principal	Interest %	Interest expenditure
				1	2	1*2
	12 % note-Specific loan for construction			3200000	12%	384000
	10% note-General purpose			6400000	10%	640000
	11% note-General purpose			12000000	11%	1320000
						2344000
	Avoidable interest=Weighted average accumulated expenditure*interest rate=3000000*9%=270000
	Weighted average accumulated expenditure:
	Date	Expense	Capitalization period	Weight	Weighted expenditure
		A	B	C=B/12	A*C
	1-Mar	6400000	10 months	0.83	5333333
	1-Jun	5280000	7 months	0.58	3080000
	31-Dec	8000000	1 months	0.08	666667
					9080000
	Weighted average interest rate for general purpose notes:
				Principal	Interest %	Interest expenditure
	10% note-General purpose			6400000	10%	640000
	11% note-General purpose			12000000	11%	1320000
				18400000		1960000
	Weighted average interest rate=196000/18400000=10.65%
	Avoidable interest:
				Principal	Interest %	Interest expenditure
	Specific note			3200000	12%	384000
	General note			5880000	10.65%	626220
				(9080000-3200000)
						1010220
	Interest to be capitalized=Lower of actual interest or avoidable interest=Lower of 2344000 or 1010220=1010220
	Hence interest to be charged to expense=Actual interest-Interest capitalized=2344000-1010220=1333780