Question

Problem 10-10 Interest capitalization; weighted average method (LO10-7) 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 March 1, 2018 June 30, 2018 October 1, 2018 January 31, 2019 April 30, 2019 August 31, 2019 $1,360,000 810,000 160,000 670,000 585,000 900,000 1,530,000 On January 1, 2018, the company obtained a $3 million construction loan with a 10% interest rate. The loan was outstanding all of 2018 and 2019. The company's other interest-bearing debt included two long-term notes of $4,700,000 and $6,700,000 with interest rates of 7% and 9%, 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. Assume the $3 million loan is not specifically tied to construction of the building. 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. < Prev 6 of 8 !! Next >

Answer 1

Answer :-

Req 1-

Calculate the amount of interest that Mason should capitalize in 2018 an 2019 using the weighted-average method.

2018

Date	Expenditures	Fraction	Weighted Average Expenditure( Expenditure × Fraction(
1/1/2018	1,360,000	12/12	1,360,000
3/1/2018	810,000	10/12	675,000
6/30/2018	160,000	6/12	80,000
10/1/2018	670,000	3/12	167,500
Total	3,000,000		2,282,500

Interest Capitalize = Total Weighted Average Expenditure × Interest rate

Total Weighted Average Expenditure=$ 2,282,500

Interest rate = 10%

Interest Capitalize = $2,282,500 × 10%

Interest Capitalize in 2018 - $228,250

In 2019 -

Expenditure on 1/1/2019 - Total Expenditure + Interest Capitalize

Expenditure on 1/1/2019 - $3,000,000 + $228,250

Expenditure on 1/1/2019 - $3,228,250

Date	Expenditures	Fraction	Weighted Average Expenditure
1/1/2019	3,228,250	9/9	3,228,250
1/31/2019	585,000	8/9	520,000
4/30/2019	900,000	5/9	500,000
8/31/2019	1,530,000	1/9	170,000
Total	6,243,250		4,418,250

To get the weighted average rate:

Principal	Interest rate	Interest
4,700,000	7%	329,000
6,700,000	9%	603,000
11,400,000		932,000

Interest rates = 932,000 / 11, 400,000 = 8.18%

Interest Capitalize in 2019 -

Upto $3,000,000 Interest rate is 10%

After $3,000,000 Interest rate is 8.18%

Therefore,Interest Capitalize =

3,000,000 × 10% = $300,000

(4,418,250 - 3,000,000) × 8.18% = $116,012.85

Interest Capitalize in 2019 = $300,000 + $116,012.85

Interest Capitalize in 2019 = $416,012.85

Req 2 - Total cost of the building -

If we add Interest Capitalize in Total Expenditure in 2019.Then,we get Total cost of Building.

Total Expenditure in 2019	$6,243,250
Interest Capitalize in 2019	$416,012.85
Total cost of building	$6,659,262.85

Total Cost of building -$6,659,262.85

Req 3-

To find out the Interest expense we will first calculated the Total Interest incurred.Then we subtract the Interest Capitalize from Total Interest incurred.

Loan Amount	Interest rate	Interest incurred (Loan amount × Interest rate)
$3,000,000	10%	$300,000
$4,700,000	7%	$329,000
$6,700,000	9%	$603,000
Total Interest incurred		$ 1,232,000

Interest expense in 2018 -

Total Interest incurred	$1,232,000
Less :- Interest Capitalize in 2018	$228,250
Interest Expense in 2018	$1,003,750

Interest expense in 2019 -

Total Interest incurred	$1,232,000
Less :- Interest Capitalize in 2019	$416,012.85
Interest expense in 2019	$815,987.15