On January 1 2018 the Mason Manufacturing Company began cons

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 $3 million construction loan with a 11% interest rate. The loan was outstanding all of 2018 and 2019. The company’s other interest-bearing debt included two long-term notes of $5,700,000 and $7,700,000 with interest rates of 5% and 7%, 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 weighted-average 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.

Solution

Requirement 1

2018:

          Expenditures for 2018:

          January 1, 2018               $1,260,000 x 12/12 =   $1,260,000

          March    1, 2018                    750,000 x 10/12 =         625,000

          June      30, 2018                    310,000 x    6/12 =         155,000

          October   1, 2018                    680,000 x    3/12 =         170,000

          Accumulated expenditures

             (before interest) -             $3,000,000

          Average accumulated expenditures -                            $2,210,000

          Interest capitalized:

          $2,210,000 x 7.04% = $155,584 = Interest capitalized in 2018

* Weighted-average rate of all debt:

      $ 3,000,000 x 11% = $   330,000                $1,154,000

        5,700,000 x   5% =       285,000                                  = 7.04% (rounded)

          7,700,000 x   7% =     539,000               $16,400,000

      $16,400,000                  $1,154,000

2019:

          January   1, 2019

          ($3,000,000 + 155,584)            $3,155,584 x   9/9 =      $3,155,584

          January 31, 2019                 1,035,000 x   8/9 =            920,000

          April   30, 2019                 1,350,000 x   5/9 =            750,000

          August 31, 2019                 2,430,000 x   1/9 =            270,000

          Accumulated expenditures

             (before interest) -             $7,970,584

          Average accumulated expenditures -                            $5,095,584

          Interest capitalized:

          $5,095,584 x 7.04% x 9/12 = $269,047 = Interest capitalized in 2019

Requirement 2

          Accumulated expenditures 9/30/19

          before interest capitalization (above)             $7,970,584

          2019 interest capitalized (above)                          269,047

          Total cost of building                                 $8,239,631

Requirement 3

2018

       $3,000,000 x 11% =                                    $   330,000

         5,700,000 x    5% =                                         285,000

         7,700,000 x    7% =                                         539,000

            Total interest incurred                                   1,154,000

            Less: Interest capitalized                                 (155,584)

               2018 interest expense                              $   998,416

2019

            Total interest incurred                                 $1,154,000

            Less: Interest capitalized                                 (269,047)

               2019 interest expense                              $   884,953