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Self-Constructed Assets Tutorial

The document describes a case where Main Inc. borrowed $3 million at 12% interest in 2016 to finance construction of a new building. In 2017, Main made expenditures totaling $3.96 million towards construction. Interest expense for the year was $1.04 million. The solution calculates that $183,000 of interest should be capitalized based on the weighted average of expenditures and avoidable interest, which is lower than actual interest. The journal entry debits construction in progress for $183,000 and credits interest expense for $857,000.

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307 views3 pages

Self-Constructed Assets Tutorial

The document describes a case where Main Inc. borrowed $3 million at 12% interest in 2016 to finance construction of a new building. In 2017, Main made expenditures totaling $3.96 million towards construction. Interest expense for the year was $1.04 million. The solution calculates that $183,000 of interest should be capitalized based on the weighted average of expenditures and avoidable interest, which is lower than actual interest. The journal entry debits construction in progress for $183,000 and credits interest expense for $857,000.

Uploaded by

Salma Hazem
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Self-Constructed Assets

E10-8 (Interest Capitalization)


On December 31, 2016, Main Inc. borrowed $3,000,000 at 12% payable annually to finance the
construction of a new building. In 2017, the company made the following expenditures related to
this building: March 1, $360,000; June 1, $600,000; July 1, $1,500,000; December 1,
$1,500,000. The building was completed in February 2018. Additional information is provided
as follows.
1. Other debt outstanding
10-year, 13% bond, December 31, 2010, interest payable annually $4,000,000
6-year, 10% note, dated December 31, 2014, interest payable annually $1,600,000
2. March 1, 2017, expenditure included land cost of $150,000
3. Interest revenue earned in 2017 $49,000

Instructions
(a) Determine the amount of interest to be capitalized in 2017 in relation to the construction
of the building.
(b) Prepare the journal entry to record the capitalization of interest and the recognition of
interest expense, if any, at December 31, 2017.

Solution
(a) Computation of Weighted-Average Accumulated Expenditures
Expenditures
Capitalization Weighted-Average Accumulated
Date Amount X Period = Expenditures
March 1 $ 360,000 10/12 $ 300,000
June 1 600,000 7/12 350,000
July 1 1,500,000 6/12 750,000
December 1 1,500,000 1/12 125,000
$3,960,000 $1,525,000
Computation of Avoidable Interest
Weighted-Average
Accumulated Expenditures X Interest Rate = Avoidable Interest
$1,525,000 .12 (Construction loan) $183,000

Actual interest
$3,000,000 X 12% $ 360,000
$4,000,000 X 13% 520,000
$1,600,000 X 10% 160,000
$1,040,000
Note: Use avoidable interest for capitalization purposes because it is lower than actual.

Constructions in Progress..............................................................................
183,000

(b)
Interest Expense*...........................................................................................
857,000
Cash ($360,000 + $520,000 + $160,000).......................................... 1,040,000

*Actual interest for year $1,040,000


Less: Amount capitalized 183,000
Interest expense debit $ 857,000

Exercise

Beluga Company began construction of a building on January 1, 2019. The company borrowed a
$500,000, 12% loan to finance the construction. Beluga made the following expenditures related
to the construction.
January 31: $450,000 June 1: $300,000 December 1: $150,000

Information related to other debt outstanding within the company is as follows. The company has
a $100,000, 14% note payable and a $50,000, 10% note payable.

Instructions
(a) Calculate the weighted average accumulated expenditures for interest capitalization
purposes.
(b) Calculate the weighted average interest rate for interest capitalization purposes.
(c) Calculate the avoidable interest for interest capitalization purposes.
(d) Calculate the actual interest for interest capitalization purposes.
(e) Determine whether the firm should capitalize avoidable or actual interest.

Solution
(a) Weighted average accumulated expenditures
(450,000 X 11/12) + (300,000 X 7/12) + (150,000 X 1/12) = $600,000

(b) Weighted average interest rate


$100,000 X 14% = $14,000
$50,000 X 10% = $5,000
Weighted average interest rate = (14,000 + 5,000) / (100,000 + 50,000) = 12.7%
(c) Avoidable interest
Weighted average accumulated expenditures = $600,000
Specific construction debt = $500,000
Difference = $600,000 - $500,000 = $100,000

Weighted average Interest rate Avoidable interest


accumulated expenditures
500,000 12% $60,000
100,000 12.7% 12,700
600,000 $72,700

(d) Actual Interest


12% construction loan = 500,000 X 12% = 60,000
14% note payable = 100,000 X 14% = 14,000
10% note payable = 50,000 X 10% = 5,000
Total interest expense = $79,000

(e) The firm should capitalize the lower of actual interest or avoidable interest. In this case,
avoidable interest is lower than actual interest and therefore the firm should capitalize
$72,700 of interest.

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