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Interest During Construction Alta Company is constructing a production complex that qualifies for interest capitalization. The...

Interest During Construction

Alta Company is constructing a production complex that qualifies for interest capitalization. The following information is available:

  • Capitalization period: January 1, 2019, to June 30, 2020
  • Expenditures on project:
    2019:
    January 1 $ 516,000
    May 1 477,000
    October 1 648,000
    2020:
    March 1 1,404,000
    June 30 684,000
  • Amounts borrowed and outstanding:
       $1.7 million borrowed at 10%, specifically for the project
       $8 million borrowed on July 1, 2018, at 12%
       $13 million borrowed on January 1, 2017, at 6%

Required:

Note: Round all final numeric answers to two decimal places.

  1. Compute the amount of interest costs capitalized each year.
    Capitalized interest, 2019 $ fill in the blank 1
    Capitalized interest, 2020 $ fill in the blank 2
  2. If it is assumed that the production complex has an estimated life of 20 years and a residual value of $0, compute the straight-line depreciation in 2020.

    $ fill in the blank 3

  3. Since GAAP requires accrual accounting, if a company capitalizes interest during the construction period it will report   income than if it had not capitalized interest. In future periods, the same company will report   income than if it had not capitalized interest.

Solutions

Expert Solution

Specific funds = 1.7 mn

General funds = 8+13 = 21 mn

Weighted average rate of General funds

Amount Rate Interest

8 mn 12% 960000

13 mn 6% 780000

Total 1740000

Weighted average rate = 1.74 mn /21 mn

= 8.2857%

Interest to capitalize in 2019

since the cost incurred in 2019 is less than 1.7 mn , we will use rate of specific borrowing only i.e. 10%

2019

Jan 1 $ 516000 for 12 months @ 10% = 51600

May 1 $ 477000 for 8 months@ 10% = 31,800

Oct 1 $ 648000 for 3 months@ 10% = 16200

  Total 1641000    99600

Interest to capitalize in 2020

Jan 1 specific borrowings 1641000 for 6 months @ 10% = 82050

March 1 out of specific borrowings 1700000- 164100 = 59000 for 4 months@ 10% = 1966.67

out of general funds 1404000-59000= 1345000 for 4 months @ 8.2857%= 37147.55

June 30 684000 out of general funds for 0 months @ 8.2857 % 0

Total 121164.22

Cost of asset

Amount spent (516000+477000+648000+1404000+684000) 3729000

Interest capitalizes in 2019 99,600

Interest capitalized in 2020 1,21,164.22

Cost of complex 39,49,764.22

Yearly Depreciation = (cost of asset - residual value) / expected useful life

= ( 3949764.22 . - 0 ) / 20

= 197488.21

Depreciation in 2020 , will stary from date of completion of asset on 30 th June

Depreciation for 6 months = $ 98,744 .11

Depreciation if interest was not capitalized

Depreciation = 3729000 /20 * 6/12 = $ 93,225

increase in depreciation due to capitalization of Interest = 98744.11 -93225 = 5519.11

Income in 2020 (if interest not capitalized) = (-)121164. 22 +5519.11 = (-) 115645.11

ekkarill92 answered 1 year ago
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