Question

Sweet Furniture Company started construction of a combination office and warehouse building for its own use at an estimated cost of $10,000,000 on January 1, 2020. Sweet expected to complete the building by December 31, 2020. Sweet has the following debt obligations outstanding during the construction period.

Construction loan-10% interest, payable semiannually, issued December 31, 2019		$4,000,000
Short-term loan-8% interest, payable monthly, and principal payable at maturity on May 30, 2021		2,800,000
Long-term loan-9% interest, payable on January 1 of each year. Principal payable on January 1, 2024		2,000,000

A. Assume that Sweet completed the office and warehouse building on December 31, 2020, as planned at a total cost of $10,400,000, and the weighted-average amount of accumulated expenditures was $7,200,000. Compute the avoidable interest on this project. (Use interest rates rounded to 2 decimal places, e.g. 7.58% for computational purposes and round final answers to 0 decimal places, e.g. 5,275.)

Avoidable Interest

$

  

  

B. Compute the depreciation expense for the year ended December 31, 2021. Sweet elected to depreciate the building on a straight-line basis and determined that the asset has a useful life of 30 years and a salvage value of $600,000. (Round answer to 0 decimal places, e.g. 5,275.)

Depreciation Expense

$

Answer 1

When borrowing a fund for the purpose of construction of an asset, the interest that incurred in the borrowing can be capitalized as part of the constructed cost provided that it will not exceed the actual interest incurred.

a) Calculation of avoidable interest:

Weighted Average Accumulated Expendiure = $7,200,000

Interest rate for other debts
- Short term loan (2,800,000 x 8%) = $224,000
- Long term loan (2,000,000 x 9%) = $180,000

Total expenditures = 2,800,000 + 2,000,000 = $4,800,000
Total Interest expense: 224,000 + 180,000 = $404,000

Interest rate for other debts = Total interest / Total expenditures = 404,000/4,800,000 = 0.0842 = 8.42%

Calculation of avoidable interest
Avoidable interest for Construction loan (4,000,000 x 10%) = $400,000
Avoidable interest for Other debt: (3,200,000 x 8.42%) = $269,440

Hence, Total avoidable interest: $400,000 + $269,440 = $669,440

b) Calculation of depreciation expense:

Building construction cost = $10,400,000
Interest for Weighted Average Accumulated Expendiure = $669,440

Total building cost = $10,400,000 + $669,440 = $11,069,440
Salvage value = $600,000
Useful life = 30 years

Depreciation expense = ($11,069,440 - $600,000) / 30 = 10,469,440 / 30 = $348,981

Hence, depreciation expense is $348,981