Question

On January 1, 2018, the Mason Manufacturing Company began construction of a building to be used as its office headquarters. The building was completed on September 30, 2019.

Expenditures on the project were as follows:

January 1, 2018	$	1,360,000
March 1, 2018		810,000
June 30, 2018		160,000
October 1, 2018		670,000
January 31, 2019		585,000
April 30, 2019		900,000
August 31, 2019		1,530,000

On January 1, 2018, the company obtained a $3 million construction loan with a 10% interest rate. The loan was outstanding all of 2018 and 2019. The company’s other interest-bearing debt included two long-term notes of $4,700,000 and $6,700,000 with interest rates of 7% and 9%, respectively. Both notes were outstanding during all of 2018 and 2019. Interest is paid annually on all debt. The company’s fiscal year-end is December 31.

Required:
1. Calculate the amount of interest that Mason should capitalize in 2018 and 2019 using the weighted-average method.
2. What is the total cost of the building?
3. Calculate the amount of interest expense that will appear in the 2018 and 2019 income statements.

Answer 1

Requirment 1:

Expenditure for 2018:

Januray 1 2018	1360000×12/12	$1360000
March 1 2018	810000×10/12	$675000
June 30 2018	160000×6/12	$80000
October 1 2018	670000×3/12	$167500
Total		$2282500

Accumulated expenditure before interest = $3000000

Average accumulated expenditure = $2282500

Interest capitalized in 2018 = $2282500 × 8.56% = $195382

* Weighted average rate of all debt =

$3000000	× 10%	$300000
$4700000	× 7%	$329000
$6700000	× 9%	$603000
$14400000		$1232000

Weighted average rate = $1232000/$14400000 = 8.56%(rounded)

For 2019:

January 1 2019	$3195382(3000000+195382) × 9/9	$3195382
January 31 2019	585000 × 8/9	$520000
April 30 2019	900000 × 5/9	$500000
August 31 2019	1530000 × 1/9	$170000
		$4385382

Accumulated expenditure = $6210382

Average accumulated expenditure = $4385382

Interest to be capitalized = $4385382 × 8.56% = $375389

Requirment 2:

Accumulated expenditure 9/30/2019 =

Before interest capitalized (above) = $6210382

2019 interest capitalized (above). = $375389

Total cost of building = $6585771

Requirment 3:

2018:

Contruction loan interest	$3000000×10%=$300000
Note 1 interest	$4700000×7% = $329000
Note 2 interest	$6700000×9% = $603000
Total interest incurred	$1232000
Less: interest capitalized	($195383)
2018 interest expense	$1036618

2019:

Total interest incurred	$1232000
Less: interest capitalized	($375389)
Total interest expense	$856611

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