Question

Early in 2017, Dobbs Corporation engaged Kiner, Inc. to design and construct a complete modernization of Dobbs's manufacturing facility. Construction was begun on June 1, 2017 and was completed on December 31, 2017. Dobbs made the following payments to Kiner, Inc. during 2017:

Date                                                Payment

June 1, 2017                                 $2,000,000

August 31, 2017                             3,000,000

December 31, 2017                        2,500,000

In order to help finance the construction, Dobbs issued

1. $1,700,000 of 10-year, 9% bonds payable, issued at par on May 31, 2017, with interest payable annually on May 3
2. 300,000 shares of no-par common stock, issued at $10 per share on October 1, 2017

In addition to the 9% bonds payable, the only debt outstanding during 2017 was a $425,000, 12% note payable dated January 1, 2013 and due January 1, 2023, with interest payable annually on January 1.

Instructions

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

1. Weighted-average accumulated expenditures qualifying for capitalization of interest cost.
2. Avoidable interest incurred during 2017.
3. Total amount of interest cost to be capitalized during 2017.

Answer 1

1.

Date	Capitalization Expenditure	Period	Weighted Average Accumulated Expense
June 1	$ 2,000,000	7/ 12	$ 1,166,667
August 31	$ 3,000,000	4/12	$ 1,000,000
December 31	$ 2,500,000	0	0
			$ 2,166,667

2.

Weighted Average Accumulated Expenditure	Interest Rate	Avoidable Interest
$ 1,700,000	9 %	$ 153,000
$ 510,000	12 %	$ 61,200
$ 2,210,000		$ 214,200

Therefore amount of avoidable interest for the year 2017 = $ 214,20

Explanation; Here $ 510,000 = ($ 425,000 * 12 % ) * 10 years .

3. Calculation of total interest cost to be capitalized during 2017 ;

9% Bond Payable , $1,700,000 * .09 (7/12) = $ 89,250

12 % Note Payable , $ 425,000 * .12 (12/12) = $ 51,000

Total= $140,250

Total interest cost to be capitalized = $140,250 of actual interest cost or $ 214,200 of avoidable interest cost which ever is lesser .

Therefore total interest cost to be capitalized during 2017 = $ 140,250

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