Question

Laserwords Inc. is a book distributor that had been operating in its original facility since 1990. The increase in certification programs and continuing education requirements in several professions has contributed to an annual growth rate of 15% for ­Laserwords since 2015. Laserwords’ original facility became obsolete by early 2020 because of the increased sales volume and the fact that Laserwords now carries CDs in addition to books.

On June 1, 2020, Laserwords contracted with Black Construction to have a new building constructed for $4,000,000 on land owned by Laserwords. The payments made by Laserwords to Black Construction are shown in the schedule below.

00000Date00000		00Amount00
July 30, 2020		$00900,000
January 30, 2021		1,500,000
May 30, 2021		1,600,000
Total payments		$4,000,000

Construction was completed and the building was ready for occupancy on May 27, 2021. Laserwords had no new borrowings directly associated with the new building but had the following debt outstanding at May 31, 2021, the end of its fiscal year.

10%, 5-year note payable of $2,000,000, dated April 1, 2017, with interest payable annually on April 1.

12%, 10-year bond issue of $3,000,000 sold at par on June 30, 2013, with interest payable annually on June 30.

The new building qualifies for interest capitalization. The effect of capitalizing the interest on the new building, compared with the effect of expensing the interest, is material.

Instructions

a.    Compute the weighted-average accumulated expenditures on Laserwords’ new building during the capitalization period.

b.    Compute the avoidable interest on Laserwords’ new building. (Round to one decimal place.)

c.    Some interest cost of Laserwords Inc. is capitalized for the year ended May 31, 2021.

1.    Identify the items relating to interest costs that must be disclosed in Laserwords’ financial statements.

2.    Compute the amount of each of the items that must be disclosed.

Answer 1

Part A

Date	Period of Capitalization	Amount($)	Weighted average expenditure ($)
Jul 30,2020	10/12	900,000	750,000
Jan 30,2021	4/12	1,500,000	500,000
May 30,2021	NIL	1,600,000	NIL
		4,000,000	1,250,000

Weighted-average accumulated expenditures on Laserwords’ new building during the capitalization period is $ 1,250,000

Part B

Interest Capitalization Rate = ( Total Interest / Total Principal ) *100

= ( 2,000,000*10% + 3,000,000*12% ) / ( 2,000,000 + 3,000,000 ) *100

= 11.20 %

Avoidable Interest = Weighted Average Expenditure *  Interest Capitalization Rate

= 1,250,000 * 11.20%

= 140,000

Avoidable interest on Laserwords’ new building is $ 140,000.

Part C

Total Interest = Interest capitalized + Interest expensed

$ 560,000 = $ 140,000 + Interest expensed

Interest expensed = $ 560,000 - $ 140,000 = $ 420,000

Disclosure Requirements

• amount of borrowing cost capitalised during the period - $ 140,000
• capitalisation rate used - 11.20 %