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

1. 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

Actual Interest is calculated as follows

Actual Interest is $228,000

Following schedule calculates the weighted-average accumulated expenditures:

Payment Date	Expenditures (A)	Capitalization Period (B)	Weight (C=B/12)	Weighted Expenditures (A×C)
01-Jan-13	400,000	12 months	1.00	400,000
01-April-13	350,000	9 months	0.75	262,500
31-Oct-13	900,000	2 months	0.167	150,300
31-Dec-13	250,000	1 month	0	0
				812,800

the weighted-average accumulated expenditures =$812,800

Out of $812,800, $400,000 is financed by specific loan.The rest i.e. $412,800 is financed out of the general loans. The interest rate on specific loan is 10% while the weighted interest rate on the general loans is calculated below.

Loan	Principal	Rate	Annual Interest
5 Year note payable	$1,000,000	8%	$80,000
10 year loan	$1,200,000	9%	$108,000
	2,200,000		$188,000

Weighted-average Interest Rate =	$188,000	= 8.545%
	$2,200,000

The above calculations furnish us with all the data needed to arrive at an estimate of avoidable interest.

Funding	Amount	Rate	Avoidable Interest
Specific Loan	$400,000	8%	$32,000
General pool	$412,800	8.545%	$35,273.76
			$67273.76

This $67273.76 is the amount of interest that could have been avoided. This much interest can be capitalized provided it doesn’t exceed the actual interest expense for the period.