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	$	1,240,000
March 1, 2018		660,000
June 30, 2018		450,000
October 1, 2018		650,000
January 31, 2019		900,000
April 30, 2019		1,215,000
August 31, 2019		2,160,000

On January 1, 2018, the company obtained a $3 million construction loan with a 12% interest rate. The loan was outstanding all of 2018 and 2019. The company’s other interest-bearing debt included two long-term notes of $5,400,000 and $7,400,000 with interest rates of 6% and 8%, 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

1. Weighted average rate for all debts = 1,216,000/15,800,000 = 7.70%

3,000,000 * 10% = 300,000

5,400,000 * 6% = 324,000

7,400,000 * 8/5 = 592,000

15,800,000 1,216,000

Expenditure of 2018:

Accumulated expenditure before interest = 1240000+660000+450000+650000 = $3,000,000

Average accumulated expenditure = 1240000*12/12 + 660000*10/12 + 450000*6/12 + 650000*3/12 = $2,177,500

Interest capitalised in 2018 = 7.70%*2,177,500 = $167,667.50

Expenditure of 2019:

Accumulated expenditure before interest = (3,000,000+167667.50) + 900000 + 1215000 + 2160000 = $7,442,667.50

Average accumulated expenditure = 3167667.50*9/9 + 900000*8/9 + 1215000*5/9 + 2160000*1/9 = $4,882,667.50

Interest capitalised in 2019 = 7.70%*9/12*4,882,667.50 = $281,974

2. Cost of building:

Expenditure in 2018 = 3,000,000

Interest capitalised in 2018 = 167,667.50

Expenditure in 2019 = 4,275,000

Interest capitalised in 2019 = 281,974

Total cost of building = $7,724,641.50

3. Interest expense in income statements = Total interest incurred - Interest capitalised in the year

Interest expense in 2018 = 1216000 - 167667.50 = $1,048,332.50

Interest expense in 2019 = 1216000 - 281974 = $934,026