Question

Problem 10-9 (Static) Interest capitalization; specific interest method [LO10-7]

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	$	1,000,000
March 1, 2021		600,000
June 30, 2021		800,000
October 1, 2021		600,000
January 31, 2022		270,000
April 30, 2022		585,000
August 31, 2022		900,000

On January 1, 2021, the company obtained a $3 million construction loan with a 10% interest rate. The loan was outstanding all of 2021 and 2022. The company’s other interest-bearing debt included two long-term notes of $4,000,000 and $6,000,000 with interest rates of 6% and 8%, 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 1:

Year 2021: Weighted-Average accumulated expenditure and interest capitalized
Date	Amount	Capitalization period	Weighted Average Accumulated Expenditures
1-Jan-21	$1,000,000	12/12	$1,000,000
1-Mar-21	$600,000	10/12	$500,000
30-Jun-21	$800,000	6/12	$400,000
1-Oct-21	$600,000	3/12	$150,000
Total	$3,000,000		$2,050,000
*Interest rate			10%
Interest capitalized in 2021			$205,000
Year 2022: Weighted-Average accumulated expenditure
Date	Amount	Capitalization period	Weighted Average Accumulated Expenditures
1-Jan-22	$3,205,000	9/9	$3,205,000
31-Jan-22	$270,000	8/9	$240,000
30-Apr-22	$585,000	5/9	$325,000
31-Aug-22	$900,000	1/9	$100,000
Total	$4,960,000		$3,870,000
Weighted average interest rate of all other debt
Debt	Amount	Interest rate	Interest amount
6% Note	$4,000,000	6%	$240,000
8% Note	$6,000,000	8%	$480,000
Totals	$10,000,000		$720,000
Weighted average rate (total interets/ total debt)		7.20%
Year 2022: Interest Capitalized
Debt		Amount
3000000*10%*9/12 =		$225,000
(3870000- 3000000)*7.20%*9/12 =		$46,980
Total interest capitalized in 2022		$271,980

Solution 2:

Computation of Cost of Building
Total expenditure before capitalization(4960000-205000)	$4,755,000
Add: Interest capitalized in 2021	$205,000
Add: Interest capitalized in 2022	$271,980
Total cost of Building	$5,231,980

solution 3:

Computation of Interest expense
Debt	Amount	Interest rate	Interest amount
Construction Loan	$3,000,000	10%	$300,000
6% Note	$4,000,000	6%	$240,000
8% Note	$6,000,000	8%	$480,000
Total interest incurred			$1,020,000
	2021	2022
Total interest incurred	$1,020,000	$1,020,000
Less: Interest Capitalized	$205,000	$271,980
Interest Expense	$815,000	$748,020