Question

Exercise 10-10 The following three situations involve the capitalization of interest. Situation I major plant facility at a cost of $4,419,000. It was esti mated that it On January 1, 2017, Martinez, Inc. signed a fixed-price contract to have Builder Associates construct would take 3 years to complete the project. Also on January 1, 2017, to finance the construction cost, Martinez borrowed $4,419,000 payable in 10 annual installments of $441,900, plus interest at the rate of 10%. During 2017, Martinez made deposit and progress payments totaling $1,657,125 under the contract; the weighted-average amount of accumulated expenditures was $883,800 for the year. The excess borrowed funds were invested in short-term securities, from which Martinez realized investment income of $254,600. What amount should Martinez report as capitalized interest at December 31, 2017? Capitalized interest Situation II During 2017, Sandhill Corporation constructed and manufactured certain assets and incurred the following interest costs in connection with those activities Interest Costs Incurred Warehouse constructed for Sandhill's own use $33,710 Special-order machine for sale to unrelated customer, produced according to customer's specifications 8,760 Inventories routinely manufactured, produced on a repetitive basis 8,320 All of these assets required an extended period of time for completion. Assuming the effect of interest capitalization is material, what is the total amount of interest costs to be capitalized?

Answer 1

Situation I

The amount of capitalized interest is calculated as below:

Capitalized Interest = Weighted Average Accumulated Expenditures*Interest Rate

Substituting values in the above formula, we get,

Capitalized Interest = 883,800*10% = $88,380 (answer for Situation I)

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Notes:

1) As the amount of debt incurred for the project is greater than the value of weighted average accumulated expenditures, we will use interest rate of 10% for the purpose of calculating capitalized interest.

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Situation II

The total amount of interest to be capitalized is determined as follows:

Total Amount of Interest to be Capitalized = Interest Cost of Warehouse Constructed for Sandhill's Own House + Interest Cost Special-Order Machine for Sale to Unrelated Customer, Produced According to Customer's Specifications

Substituting values in the above formula, we get,

Total Amount of Interest to be Capitalized = 33,710 + 8,760 = $42,470 (answer for Situation II)

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Notes:

As per applicable rules, the interest cost with respect to assets that are constructed for self-use or assets that are meant for sale/lease and considered as discrete projects can be capitalized. Interest cost incurred towards inventories manufactured on a routine basis cannot be capitalized.

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Situation III

The value of capitalized interest is arrived as below:

Capitalized Interest = Expenditures for the Partially Completed Structure/2*Interest Rate

Substituting values in the above formula, we get,

Capitalized Interest on Teal's Financial Statements = 6,529,600/2*11% = $359,128 (answer for Situation III)

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Notes:

1) As the expenditures have been incurred evenly throughout the year, the value of weighted average accumulated expenditures will be arrived by dividing the total expenditures during the year by 2.

2) The value of interest cost to be capitalized cannot be more than the actual interest cost incurred by the company. In the given case, the actual interest cost is $1,026,080 (9,328,000*11%).