Question

Problem 10-9 (Algo) Interest capitalization; specific interest method [LO10-7] 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 $ 1,680,000 March 1, 2021 1,260,000 June 30, 2021 1,460,000 October 1, 2021 1,260,000 January 31, 2022 369,000 April 30, 2022 702,000 August 31, 2022 999,000 On January 1, 2021, the company obtained a $4,000,000 construction loan with a 12% interest rate. The loan was outstanding all of 2021 and 2022. The company’s other interest-bearing debt included two long-term notes of $3,000,000 and $7,000,000 with interest rates of 8% and 10%, 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

Answer:

2021 avoidable interest $453,000

2022 avoidable interest$   382,348.50  

Total Cost: 8,565,348.50      

Interest expense 2021:  $ 967,000

Interest expense 2022:  $ 1,037,651.5‬

Explanation:

First, we solve for the weighted capitalized expenditures:

construction capitalized interest

Month        Nominal           Weight         Weighted

Jan 1  1,680,000.00  1  1,680,000.00

March 1  1,260,000.00  0.83  1,050,000.00

June 30  1,460,000.00  0.5      730,000.00

October 1 1,260,000.00  0.25      315,000.00

                                   3,775,000.00

Specific borrowing

3,775,000 x .12 =  453,000.00  

As we don't have more expenditure subject to capitalization we avoid this interest.

2022

Month        Nominal           Weight         Weighted

Jan 1                                     3,775,000.00

Jan 31  $ 369,000.00  0.11                 41,000.00

April 30  $ 702,000.00  0.55             390,000.00

August 31 $ 999,000.00  0.11                111,000.00

                                            4,317,000.00

Then, we solve for the capitalized interest:

specifit interest:

4,000,000 x 12% x 9/12 =  360,000.00  

weigthed rate for non-specific borrowing:

principal rate interest

3,000,000 0.08 240,000

7,000,000 0.1 700,000

10,000,000  940000

total interest / total principal  0.094

317,000.00 x  0.094 x 9/12 =  22,348.50  

total interest capitalized $   382,348.50  

 

 

Total cost of the building:

sum of capital expenditures nominal:

7,730,000.00

plus capitalized interest 2021:

453,000

plus capitalized interest 2022:

382,348.50      

Total Cost:     8,565,348.50  

Interest expense 2021:

480,000 specific borrowing + 940,000 non-specifit - 453,000 avoided

967,000

Interest expense 2022:

480,000 specific borrowing + 940,000 non-specifit -  382,348.50 avoided

1.037.651,5‬