A company constructs a building for its own use. Construction began on January 1

Question

A company constructs a building for its own use. Construction began on January 1 and ended on December 30. The expenditures for construction were as follows: January 1, $640,000; March 31, $740,000; June 30, $540,000; October 30, $1,020,000. To help finance construction, the company arranged a 9% construction loan on January 1 for $980,000. The company’s other borrowings, outstanding for the whole year, consisted of a $4 million loan and a $6 million note with interest rates of 11% and 8%, respectively.

Explanation / Answer

calculation of the amount of interest capitalised in the year;

Srep -1 :Determine the time-weighting average accumulated expenditures

Step 2:Calculate the amount of interest to be capitalized.

The average accumulated expenditures $1,638,400 is higher than the original construction loan $980,000. This suggests that a portion of the expenditures in this year (i.e., 1,638,400-980,000) is funded by other outstanding debts. We must take that into account.

Note that the average interest rate forthe outstanding debts is
(4,000,000× 11% +6,000,000×8%) ÷ (4,000,000+6,000,000) = 0.092 = 9.2%
Thus, the interest capitalized in this year is:(980,000 × 9% + (1,638,400-980,000) × 9.2%) = $148,772.8
Taken together, the total cost of the building project is (640,000 + 740,000 + 540,000 + 1,020,000) + 148,772.8 = $3,088,772.8

Date Expenditure Weight Average = Expenditure * weights January 1 $640,000 12/12=1 640,000 * 1 = 640,000 March 31 $740,000 9/12 =0.75 740,000 * 0.75 =555,000 June 30 $540,000 6/12 = 0.5 540,000*0.5=270,000 October 30 $1,020,000 2/12 = 0.17 1,020,000*0.17 = 173,400 Average accumulated expenditures $1,638,400

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