Question

Thornton Industries began construction of a warehouse on July 1, 2018. The project was completed on March 31, 2019. No new loans were required to fund construction. Thornton does have the following two interest-bearing liabilities that were outstanding throughout the construction period: $3,000,000, 6% note $5,000,000, 2% bonds Construction expenditures incurred were as follows: July 1, 2018 $ 540,000 September 30, 2018 750,000 November 30, 2018 750,000 January 30, 2019 690,000 The company’s fiscal year-end is December 31. Required: Calculate the amount of interest capitalized for 2018 and 2019.

Answer 1

Interest to be capitalize the lesser of Actual interest cost and Avoidable interest.

1. Amount of interest capitalized for 2018:

i. Calculation of Weighted Average Accumulated expenditures:

Date	Actual Expenditure	x	Capitalization Period	=	Weighted Average Accumulated expenditures
07/01/2018	$540,000	x	6/12	=	$270,000
09/30/2018	$750,000	x	3/12	=	$187,500
11/30/2018	$750,000	x	1/12	=	$62,500
	$2,040,000				$520,000

ii.Calculation of Actual interest:

Debt	x	Interest Rate*	=	Actual Interest
$3,000,000	x	3%	=	$90,000
$5,000,000	x	1%	=	$50,000
$8,000,000				$140,000

*Interest rate for 6 months

Weighted-Average interest rate on general debt = 140,000/8,000,000 = 1.75%

iii. Calculation of Avoidable interest:

Accumulated Expenditures	x	Interest Rate*	Avoidable Interest
520,000	x	1.75%	$9,100

*Interest rate is Weighted-Average interest rate which is computed above.

Amount to be capitalized: $9,100 because it is lesser.

.

2. Amount of interest capitalized for 2019:

i. Calculation of Weighted Average Accumulated expenditures:

Date	Actual Expenditure	x	Capitalization Period	=	Weighted Average Accumulated expenditures
01/30/2018	$690,000	x	2/3	=	$460,000

ii.Calculation of Actual interest:

Debt	x	Interest Rate	=	Actual Interest
$3,000,000	x	1.50%	=	$45,000
$5,000,000	x	0.50%	=	$25,000
$8,000,000				$70,000

*Interest rate for 3 months

Weighted-Average interest rate on general debt = 70,000/8,000,000 = 0.875%

iii. Calculation of Avoidable interest:

Accumulated Expenditures	x	Interest Rate	Avoidable Interest
$460,000	x	0.875%	$4,025

*Interest rate is Weighted-Average interest rate which is computed above.

Amount to be capitalized: $4,025 because it is lesser.