Red Man Construction is constructing a building Construction

Red Man Construction is constructing a building. Construction began on January 1 and was completed on December 31. Expenditures were $6,400,000 on March 1, $5,280,000 on June 1, and $8,000,000 on December 31. Red Man borrowed $3,200,000 on January 1 on a 5-year, 12% note to help finance construction of the building. In addition, the company had outstanding all year a 10%, 3-year, $6,400,000 note payable and an 11%, 4-year, $12,000,000 note payable. what amount of interest should be charged to expense?

Solution

Actual interest expenditure incurred: Principal Interest % Interest expenditure 1 2 1*2 12 % note-Specific loan for construction 3200000 12% 384000 10% note-General purpose 6400000 10% 640000 11% note-General purpose 12000000 11% 1320000 2344000 Avoidable interest=Weighted average accumulated expenditure*interest rate=3000000*9%=270000 Weighted average accumulated expenditure: Date Expense Capitalization period Weight Weighted expenditure A B C=B/12 A*C 1-Mar 6400000 10 months 0.83 5333333 1-Jun 5280000 7 months 0.58 3080000 31-Dec 8000000 1 months 0.08 666667 9080000 Weighted average interest rate for general purpose notes: Principal Interest % Interest expenditure 10% note-General purpose 6400000 10% 640000 11% note-General purpose 12000000 11% 1320000 18400000 1960000 Weighted average interest rate=196000/18400000=10.65% Avoidable interest: Principal Interest % Interest expenditure Specific note 3200000 12% 384000 General note 5880000 10.65% 626220 (9080000-3200000) 1010220 Interest to be capitalized=Lower of actual interest or avoidable interest=Lower of 2344000 or 1010220=1010220 Hence interest to be charged to expense=Actual interest-Interest capitalized=2344000-1010220=1333780