Question

During 2020, Barden Building Company constructed various assets at a total cost of $14,700,000. The weighted average accumulated expenditures on assets qualifying for capitalization of interest during 2020 were $9,800,000. The company had the following debt outstanding at December 31, 2020:

1.   10%, 5-year note to finance construction of various assets,

      dated January 1, 2020, with interest payable annually on January 1       $6,300,000

2.   12%, ten-year bonds issued at par on December 31, 2014, with interest

      payable annually on December 31                                                                    7,000,000

3.   9%, 3-year note payable, dated January 1, 2019, with interest payable

      annually on January 1                                                                                         3,500,000

Instructions

Compute the amounts of each of the following (show computations).

1.   Avoidable interest.

2.   Total interest to be capitalized during 2020.

Answer 1

Total cost = $14,700,000

Weighted average accumulated expenditures on assets =$9,800,000, from the $9,800,000 , $6,300,000 is financed by 10%, 5 year note.

Therefore amounts out of the general loans = 14,700,000 - 9,800,000 = 4,900,000

The interest cost on specific loan is 10% while the weighted interest rate on the general loans is as follows:

Annual interest rate at 12%, ten year bond = 12% * 7,000,000 = $840,000

Annual interest rate at 9%, 3 year note payable = 9% * 3,500,000 = $315,000

Weighted average interest rate = (840,000 + 315,000) / (7,000,000 + 3,500,000)

= 1,155,000 / 10,500,000 = 11%

Avoidable interest for specific loan = 10% * 6,300,000 = $630,000

Avoidable interest for general loan = 11% * 4,900,000 = $539,000

Total avoidable interest = 630,000 + 539,000 = $1,169,000

Actual interest rate at 5 year note = 10% * 6,300,000 = $630,000

Actual interest rate at 10 year bonds = 12% * 7,000,000 = $840,000

Actual interest rate at 3 year note payable = 9% * 3,500,000 = $315,000

Total actual interest rate = 630,000 + 840,000 + 315,000 = $1,785,000

Here Interest to be capitalised is avoidable interest, as interest to be capitalised is choose from the lesser of avoidable interest or actual interest. Here avoidable interest is lesser than the actual interest.

1. Avoidable interest = $1,169,000

2. Interest to be capitalised = $1,169,000