Question

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 March 1, 2021 June 30, 2021 October 1, 2021 January 31, 2022 April 30, 2022 August 31, 2022 $1,280,000 720,000 920,000 720,000 288,000 621,000 918,000 On January 1, 2021, the company obtained a $3,200,000 construction loan with a 15% 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 11% and 13%, 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

Statement No. 34 issued by Financial Accounting Standard Board in 1979, lays down principles for Capitalization of Interest cost for certain assets. Business can use specific method or weighted average method to determine portion of interest cost to be capitalized.

In light of given principles, we shall answer following questions one by one.

(Question : 1 ) Amount of Interest to be Capitalized in 2021 and 2022:

Step: 1 For year 2021, determine average accumulated expenditure.

Expenditures Months January 01, 2021 $1,280,000 X 12/12 = March 01, 2021 $720,000 X 10/12 = June 30, 2021 $920,000 X 6/12 = October 01, 2021 $720,000 X 3/12 = Average accumulated expenditure $1,280,000 $600,000 $460,000 $180,000 $2,520,000

Step: 2 Calculate Interest Cost to be Capitalized:

Interest cost to be capitalized for 2021 = $2,520,000 X 15% (Using Construction Loan)

      = $378,000

Amount of interest cost to be capitalized in 2021 = $378,000

Account balance of asset at end of 2021 = ($1,280,000 + $720,000 + $920,000 + $720,000) + $378,000 = $4,018,000

Step 3: For year 2022, determine average accumulated expenditure:

Expenditures Months January 01, 2022 $4,018,000 X 09/09 = January 31, 2022 $288,000 X 08/09 = April 30, 2022 $621,000 X 05/09 = August 31, 2022 $918,000 X 01/09 = Average accumulated expenditure $4,018,000 $256,000 $345,000 $102,000 $4,721,000

It can be noticed that actual average accumulated expenditure in $4,721,000 which exceeds amount o construction loan of $3,200,000. hence it can be said that difference portion of expenditure of $1,521,000 ($4,721,000 - $3,200,000) is funded by utilization of Two long term notes.

Step 4: To calculate Interest cost to be capitalized, we need to find out Weighted average rate of Interest for long term notes:

Long term note Interest rate $3,000,000 X 11% $7,000,000 X 13% Amount $330,000 $910,000 $1,240,000

Weighted average rate of interest = $1,240,000 / ($3,000,000 + $7,000,000) X 100

= 12.4%

Interest cost to be capitalized on 2022 = [($3,200,000 X 15%) + ($1,521,000 X 12.4%)] X 9/12

   = ($480,000 + $188,604) X 9/12

   = ($480,000 X 9/12) + ($188,604 X 9/12)

   = $360,000 + $141,453

= $501,453

Amount of interest cost to be capitalized in 2022 = $501,453

Amount of Interest to be capitalized:

For Year 2021 = $378,000

For Year 2022 = $501,453

(Question 2) Total Cost of Building:

Total Cost of Building = Expenditures + Interest cost to be capitalized

=($1,280,000 + $720,000 + $920,000 + $720,000 + $288,000 + $621,000 + $918,000 ) + $378,000 + $501,453

= $6,346,453

(Question 3) Amount of Interest expense for Year 2021 and 2022:

For Year 2021: Debt Components Rate Total Interest To be Capitalized Expense Construction Loan $3,200,000 15% $480,000 $378,000 $102,000 Long term notes $10,000,000 12.4% $1,240,000 NA $1,240,000 Amount of Interest to be shown in Income Statement in year 2021 $1,342,000 For Year 2022: Debt Components Rate Total Interest To be Capitalized Expense Construction Loan $3,200,000 15% $480,000 $120,000 Long term notes $10,000,000 12.4% $1,240,000 $141,453 $1,098,547 Amount of Interest to be shown in Income Statement in year 2022 $1,218,547 % $452.0000 $189;