Question

Calculating Capitalized Interest Kit Company borrows $5 million at 12% on January 1, 2016, specifically for the purpose of financing the construction of a building that is expected to take 18 months to complete. Kit invests the total amount at 11% until it makes payments for the construction project. During the first year of construction, Kit incurs the following expenditures related to this construction project: January 1 $1,000,000 April 1 1,600,000 October 1 1,200,000 December 31 500,000 Required: Compute the amount of interest expense Kit would capitalize related to the construction of the building. $ Compute the amount of interest revenue Kit would recognize. $ Assume that Kit uses IFRS. What amount of interest would be capitalized related to the construction of the building? $

Answer 1

IAS 23 Borrowing Costs:

As per the IAS 23, "A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale"

Construction of a building is a qualifying asset. It takes substantial period of time for construction.

Amount of interest expenses related to the construction of the building:(In $)

Step 1: we need to find the average expenses incurred for the building

Date of payment	Amount Withdrawn for Construction ($) (a)	Months (b)	Average Expenses ($) =(a)*(b)
01-01-2016	1,000,000.00	12/12	1,000,000.00
01-04-2016	1,600,000.00	9/12	1,200,000.00
01-10-2016	1,200,000.00	3/12	300,000.00
31-12-2016	500,000.00	0	0
Total	4,300,000.00		2,500,000.00

Note: Last amount withdrawn on 31st December (last day of the year) will not qualify for interest calculation.

Step 2: Apply the Interest rate of borrowing on the above total average expenses :

= $ 2,500,000 * 12/100

= $ 300,000

Computation of the amount of interest revenue Kit would recognize: (In $)

We can calculate the interest based the on the following method :

Date of payment	Opening Value ($) (a)	Amount Withdrawn for Construction ($) (b)	Closing Value ($) (c) =(a)-(b)	Months (d)	Interest Income ($) (e) =(c)*(d)*11%
01-01-2016	5,000,000.00	1,000,000.00	4,000,000.00	0	0
01-04-2016	4,000,000.00	1,600,000.00	2,400,000.00	3/12	110,000.00
01-10-2016	2,400,000.00	1,200,000.00	1,200,000.00	6/12	132,000.00
31-12-2016	1,200,000.00	500,000.00	700,000.00	3/12	33,000.00
Total Interest					275,000.00

AS per IAS 23 Clause 12 "To the extent that an entity borrows funds specifically for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalisation as the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investment of those borrowings"

Based on this provision, we can reduce the interest income from the Interest expenses.

So, $ 300,000 - $ 275,000 = $ 25,000

$ 25,000 is to be capitalized related to the construction of the building by Kit Company as par IFRS (IAS 23).