Question

On January 1, 2021, the company obtained a $3 million loan with a 12% interest rate. The building was completed on September 30, 2022. Expenditures on the project were as follows:

January 1, 2021	$	1,170,000
March 1, 2021		990,000
June 30, 2021		110,000
October 1, 2021		730,000
January 31, 2022		855,000
April 30, 2022		1,170,000
August 31, 2022		2,070,000

On January 1, 2021, the company obtained a $3 million construction loan with a 12% interest rate. Assume the $3 million loan is not specifically tied to construction of the building. The loan was outstanding all of 2021 and 2022. The company’s other interest-bearing debt included two long-term notes of $5,300,000 and $7,300,000 with interest rates of 5% and 7%, 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 weighted-average method. Calculate the interest expense for 2021 and 2022.
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

Interest to be capitalized in 2020:
	Weighted average accumulated expenditure:
			Amount	Months	Weighted Average expenses
	Jan 1.Expenses		1170000	12	(1170000*12/12)=1170000
	Mar 1.Expenses		990000	10	(990000*10/12)=825000
	June 30.Expenses		110000	6	(110000*6/12)=55000
	Oct 1.Expenses		730000	3	(730000*3/12)=182500
	Total					2232500
	Month is calculated from the date of expenditure incurred till Dec 31.
	Weighted average interest rate
				Amount of loan	Interest %	Interest
	12% loan			3000000	12%	360000
	5% note			5300000	5%	265000
	7% note			7300000	7%	511000
				15600000		1136000
	Weighted average interest rate=Total interest expenses/Total amount of loan=1136000/15600000=0.0728=7.28%
	Avoidable interest=Weighted average accumulated expenditure*Weighted average interest rate=2232500*7.28%=$ 162526
	Actual interest paid=$ 1136000
	Since total avoidable interest is less than actual interest,Interest to be capitalized=Avoidable interest=$ 162526
	Interest to be capitalized in 2021:
	Weighted average accumulated expenditure:
			Amount	Months	Weighted Average expenses
	Jan 31.Expenses		855000	8	(855000*8/9)=760000
	Apr 30.Expenses		1170000	5	(1170000*5/9)=650000
	Aug 31.Expenses		2070000	1	(2070000*1/6)=345000
	Total					1755000
	Construction completed on Sep 30.Hence, total months=9 months
	Month is calculated from the date of expenditure incurred till Sep 30.
	Weighted average interest rate:
				Amount of loan	Interest %	Interest till sep 30.
	12% loan			3000000	12%	270000
	5% note			5300000	5%	198750
	7% note			7300000	7%	383250
				15600000		852000
	Weighted average interest rate=Total interest expenses/Total amount of loan=852000/15600000=0.0546=5.46%
	Avoidable interest=Weighted average accumulated expenditure*Weighted average interest rate=1755000*5.46%=$ 95823
	Actual interest paid=$ 852000
	Since total avoidable interest is less than actual interest,Interest to be capitalized=Avoidable interest=$ 95823
2	Total cost of building:
							$
	Total expenditures on the project
	(1170000+990000+110000+730000+855000+1170000+2070000)						7095000
	Interest capitalized
	2020						162526
	2021						95823
	Total cost of building						7353349
3	Interest expense to be recognized in income statement=Actual interest-Interest capitalized
	2020	Interest expense to be recognized in income statement=1136000-162526=$ 973474
	2021	Interest expense to be recognized in income statement=852000-95823=$ 756177