On January 1, 2018, the Mason Manufacturing Company began construction of a buil
ID: 2593509 • Letter: O
Question
On January 1, 2018, the Mason Manufacturing Company began construction of a building to be used as its office headquarters. The building was completed on September 30, 2019.
Expenditures on the project were as follows:
On January 1, 2018, the company obtained a $4,200,000 construction loan with a 16% interest rate. The loan was outstanding all of 2018 and 2019. The company’s other interest-bearing debt included two long-term notes of $4,000,000 and $6,000,000 with interest rates of 12% and 14%, respectively. Both notes were outstanding during all of 2018 and 2019. 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 2018 and 2019 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 2018 and 2019 income statements.
Explanation / Answer
1.
To calculate how much interest to capitalize, we will calculate the how much amount is used for how many months in each year.
Interest to be Capitalize in 2018
1 January 2018(Amount is used for whole year) = 1,710,000 * 12/12 months = 1,710,000
1 March = 1,320,000 * 8/12 months = 880,000
30 June = 1,520,000 * 6/12 months = 760,000
1 October = 1,320,000 * 3/12 months = 330,000
Total Expenditures during 2018 = (1,710,000 + 1,320,000 + 1,520,000 + 1,320,000)
Total Expenditures during 2018= 5,870,000
Average Expenditure = (1,710,000 + 880,000 + 760,000 + 330,000)
Average Expenditure = 3,680,000
Interest to be capitalized in 2018 = 3,680,000*16%
Interest to be capitalized in 2018 = 588,800
Interest to be Capitalize in 2019
The building is completed in Sept 2019 so we will calculate average of 9 months
As we used 5,870,000 and interest 588,800 for the year 2019.
1 January 2019(Amount is used for whole year) = (5,870,000+588,800) * 9/9 months = 6,458,800
31 January 2019 = 378,000*8/9 months = 336,000
30 April = 711,000* 5/9 months = 395,000
31 August = 1,008,000* 1/9 months = 112,000
Total Expenditure till now = 8,555,800
Average = 7,301,800
Average interest of other long term liability = Total Interest / Total liability
= [(4,000,000*12%) + (6,000,000*14%)] / (4,000,000+6,000,000)
= 13.2%
Interest to be capitalized in 2019 = 16% on 4,200,000 and after that 13.2%
= (4,200,000*16%) + (7,301,800- 4,200,000)*13.2%
Interest to be capitalized in 2019 = 1,081,437.6
2.
Total cost of the building = Total Expenditure till 2019 + Interest to be capitalized in 2019
= 8,555,800 + 1,081,437.6
Total cost of the building = 9,637,237.6
3.
Total Interest per year = (4,200,000*16%) + (4,000,000*12%) + (6,000,000*14%)
Total Interest per year = 1,992,000
Interest expense that will appear in 2018 = Total Interest – Capitalized interest
= 1,992,000 – 588,800
Interest expense that will appear in 2018 = 1,403,200
Interest expense that will appear in 2019 = Total Interest – Capitalized interest
= 1,992,000 – 1,081,437.6
Interest expense that will appear in 2019 = 910,562.4
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