Question

Cooper, Inc., is constructing a building that qualifies for interest capitalization. The following information is available:

Capitalization period: January 1, 2013-December 31, 2014

            Expenditures on project (incurred evenly):

2013	$30,000
2014	$50,000

Amounts borrowed and outstanding (all debt incurred January 1, 2013)

          $10,000 at 10% (specifically for the construction project)

          $18,000 at 11% (general debt)

            $30,000 at 13% (general debt)

Required:

a.	Compute the amount of interest that should be capitalized in 2013 and 2014. (Round interest rates to the nearest hundredths, e.g., 07.62%.)
b.	Assume that in 2013 unused borrowed funds were invested and earned interest revenue amounting to $800. How much interest now should be capitalized to the asset account in 2013?

Answer 1

Calculation of average interest rate other than for specific borrowing

Amount of loan	Rate of interest	amount of interest
$18000	11%	18000*11/100 = 1980
$30000	13%	30000*13/100 = 3900
Total= $48000		Total = 5880
Weighted average rate of interest	= 5880/48000*100	= 12.25%

a. Amount of interest to be capitalized in 2013 2014

2013

on specific borrowing ($10000*10%) =$ 1000

On non specific borrowing

( ($30000-$10000)*12.25%) =$ 2450

Amount of interest to be capitalized. = $ 3450

2014

on specific borrowing ($10000*10%)     =$ 1000

On non specific borrowing

( ($30000+$50000-$10000)*12.25%) =$ 8575    

Actual borrowing cost incured on non specific borrowing

( $18000 * .11 + $ 30000*.13 ) =$ 5880

Amount eligible for capitalization (note1)       = $ 5880

Total amount of interest to be capitalized 2014

= $1000 + $5880 = $6880

Note

The amount of borrowing costs capitalized should not exceed the actual interest cost.

answer for question b

in determining the amount of borrowing costs eligible for capitalisation during a period, any income earned on the temporary investment of those borrowings is deducted from the borrowing costs incurred

Assume that the interest revenue  earned from the investments made out of borrowings eligible for capitalisation

In this case the amount of interest capitalized to the asset account 2013 is ($ 3450 -$800) = $ 2650