Question

On January 1, 2021, the Mason Manufacturing Company began construction of a building to be used as its office headquarters. The building was completed on September 30, 2022. Expenditures on the project were as follows:

January 1, 2021 $ 1,500,000

March 1, 2021 1,200,000

June 30, 2021 1,400,000

October 1, 2021 1,200,000

January 31, 2022 360,000

April 30, 2022 693,000

August 31, 2022 990,000

On January 1, 2021, the company obtained a $4,000,000 construction loan with a 14% interest rate. The loan was outstanding all of 2021 and 2022. The company’s other interest-bearing debt included two long-term notes of $1,000,000 and $4,000,000 with interest rates of 10% and 12%, respectively. Both notes were outstanding during all of 2021 and 2022. 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 2021 and 2022 using the specific interest method.

2. What is the total cost of the building?

3.Calculate the amount of interest expense that will appear in the 2021 and 2022 income statements.

Answer 1

Cost of Building:
Expenditures in 2018	$              5,300,000
Interest capitalized in 2018	$                  490,000
Expenditures in 2019	$              2,043,000
Interest capitalized in 2019	$                  646,635
Total cost of building	$              8,479,635
Interest Expense for 2018:
Total interest incurred	$              1,140,000
(4000000*0.14)+(1000000*0.1)+(4000000*0.12)
Less: Capitalized	$               (490,000)
2018 expense	$                  650,000
Interest Expense for 2019:
Total interest incurred	$              1,140,000
Less: Capitalized	$               (646,635)
2019 expense	$                  493,365

Workings:

Expenditures 2018		months	weighted amount
Jan-01	$              1,500,000	12/12	$              1,500,000
Mar-01	$              1,200,000	10/12	$              1,000,000
Jun-30	$              1,400,000	6/12	$                  700,000
Oct-01	$              1,200,000	3/12	$                  300,000
	$              5,300,000		3500000
so we have
Accumulated expenditures (before interest) -	$ 5,300,000
Average accumulated expenditures -	$ 3,500,000
Interest capitalised
3500000*0.14	490000
Expenditures 2019		months	weighted amount
Jan-01	$              5,790,000	9/9	$              5,790,000
Jan-31	$                  360,000	8/9	$                  320,000
Apr-30	$                  693,000	5/9	$                  385,000
Aug-31	$                  990,000	1/9	$                  110,000
	$              7,833,000		6605000
so we have
Accumulated expenditures (before interest) -			$ 7,833,000
Average accumulated expenditures -			$ 6,605,000
Weighted average rate of all other debt
$                                                                                      1,000,000	10%	100000
$                                                                                      4,000,000	12%	480000
5000000	/	580000	11.60%
Interest capitalised in 2019
4000000*0.14*9/12	$                  420,000
2605000*0.116*9/12	$                  226,635
	$                  646,635