Question

During 2020, Karen Building Company constructed various assets at a total cost of $12,600,000. The weighted average accumulated expenditures on assets qualifying for capitalization of interest during 2020 were $8,130,000. The company had the following debt outstanding at December 31, 2020:
1. 10%, 5-year note to finance construction of various assets, dated January 1, 2020, with interest payable annually on January 1 $5,205,000
2. 12%, ten-year bonds issued at par on December 31, 2014, with interest payable annually on December 31 6,047,000
3. 9%, 3-year note payable, dated January 1, 2019, with interest payable annually on January 1 3,023,500

Compute the amounts of each of the following.

a. Avoidable interest
b. Total interest to be capitalized during 2020

Answer 1

Answer:

a. $842,250

b. $842,250

Explanation:

The computation is shown below:

a. For avoidable interest

Weighted average               Interest rate applied  avoidable interest

accumulated expenditures

$5,205,000                               10%                           $520,500

$2,925,000                                11%                            $321,750

Total                                                                             $842,250

($8,130,000 - $5,205,000)

Working note for interest rate applied

Particulars                   Principal                Interest

12% ten year bond    $6,047,000            $725,640    

9% 3 year bond         $3,023,500            $272,115

total                            $9,070,500            $997,755

Now the interest rate is

= $997,755 ÷ $9,070,500

= 11%

2. Now the total interest capitalized is

Total interest is

= $520,500 + $725,640 + $272,115

= $1,518,255

And, the total avoidable interest is $842,250

So we considered the lesser amount i.e. $842,250