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 $1,310,000 1,020,000 1,220,000 1,020,000 333,000 666,000 963,000 On January 1, 2021, the company obtained a $3,700,000 construction loan with a 12% 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 8% and 10%, 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

Solution

Mason Manufacturing Co

1. Calculate the amount of interest to be capitalized in 2021 and 2022 using the specific interest method:

Expenditures in 2021:

Date	Computations	Amount
Jan 1, 2021	$1,310,000 x 12/12	$1,310,000
Mar 1, 2021	$1,020,000 x 10/12	$850,000
June 30, 2021	$1,220,000 x 6/12	$610,000
Oct 1, 2021	$1,020,000 x 3/12	$255,000
Accumulated Expenditure (before interest)	$4,570,000
Average accumulated expenditure		$3,025,000

Amount of interest capitalized in 2021:

$3,025,000 x 12% = $363,000

Expenditures for 2022:

Date	Computations	Amount
Jan 1, 2022	(3,700,000 + 333,000) x 9/9	$4,033,000
Jan 31, 2022	$333,000 x 8/9	$296,000
Apr 30, 2022	$666,000 x 5/9	$370,000
August 31, 2022	$963,000 x 1/9	$107,000
Accumulated expenditure (before interest)	$5,995,000
Average accumulated expenditure		$4,806,000

Interest capitalization for 2022:

Date	Computations	Amount
Jan 1, 2022	(3,700,000 + 333,000) x 9/9	$4,033,000
Jan 31, 2022	$333,000 x 8/9	$296,000
Apr 30, 2022	$666,000 x 5/9	$370,000
August 31, 2020	$963,000 x 1/9	$107,000
Accumulated expenditure (before interest)	$5,995,000
Average accumulated expenditure		$4,806,000

Interest capitalized in 2022 –

More than 3,700,000 x 12% x 9/12 = $333,000

More than (4,806,000 – 3,700,000) x 9.4% x 9/12 = $77,973

Interest capitalization in 2022 = 333,000 + 77,973 = $410,973

Computation of weighted average rate of all other debt:

3,000,000 x 8% = $240,000

7,000,000 x 10% = $700,000

Weighted average rate = (240,000 + 700,000)/10,000,000 = 9.4%

2. Computation of total cost of building:

Total cost of building
Accumulated expenditure (before interest) on 30/9/2022	$5,995,000
Add: interest capitalized in 2022	$410,973
Total cost of building	$6,405,973

3. Calculation of the amount of interest expense that would appear in the 2021 and 2022 income statements:

Interest expenditure for 2021:

interest expenditure for 2021
$3,700,000 x 12%	$444,000
$3,000,000 x 8%	$240,000
$7,000,000 x 10%	$700,000
total interest incurred	$1,384,000
Less: interest capitalized in 2021	($363,000)
Interest expense 2021	$1,021,000

Interest expenditure for 2022:

total interest incurred	$1,384,000
less: interest capitalized	($410,973)
Interest expense 2022	$973,027