[Anonymous]

Can someone please help me understand the solution for this question? I get everything except how they calculate the Average expenditure. The way I learned from the book and did it in homework is here below. Thank you so much!!

200000* 12/12 =200000

600000* 7/12 = 350000

300000 *1/12= 25000

MY WAAE = $575,000

At the beginning of the year, Cann Co. started construction on a new $2 million addition to its plant. Total construction expenditures made during the year were $200,000 on January 2, $600,000 on May 1, and $300,000 on December 1. On January 2, the company borrowed $500,000 for the construction at 12%. The only other outstanding debt the company had was a 10% interest rate, long-term mortgage of $800,000, which had been outstanding the entire year. What amount of interest should Cann capitalize as part of the cost of the plant addition?

a. $140,000

b. $72,500

c. $132,000

d. $60,000

Explanation

Choice “b” is correct. Construction period interest is capitalized based on the weighted average of accumulated construction expenditures. The interest rate paid on borrowings specifically for asset construction is used first to determine the amount of interest cost capitalized. If the average accumulated expenditures outstanding exceed the amount of the specific new borrowing, interest on the excess is computed based on the interest rate for other borrowings of the company.

Average expenditures:

$200,000 4/12 (Jan−Apr) $ 66,667

$800,000 7/12 (May−Nov) 466,667

$1,100,000 1/12 (Dec) 91,666

Average Expenditures $ 625,000

Capitalized Interest Expense:

Construction loan

$500,000 × 12%

$ 60,000

Excess Expenditures

$125,000 × 10%

12,500

Capitalized interest

$ 72,500

Choice “a” is incorrect. Only the interest related to construction expenditures is capitalized. The entire amount of interest is not capitalized.

Choice “c” is incorrect. The capitalized interest is based on the weighted average construction expenditures during the year and the rates of interest for specific borrowings. It is not calculated as the year end amount of expenditures at the construction loan rate.

Choice “d” is incorrect. The capitalized interest is not based simply on the construction loan interest paid. It is based on the average expenditures and the interest rates paid by the company.

[km75969]

It looks like the issue with your calculation is that the $200,000 expenditure on May 1 was outstanding for 8 months rather than the 7 that you used in your calculation. I have to count these on my fingers to make sure I get the correct number of months. 🙂

AUD: (2/24/15) 75 *Whew!*
FAR: (5/29/15) 87
REG: (8/27/15) 77
BEC: (10/26/15)

[Anonymous]

Nice catch and Thank you I appreciate it so much! Glad its just a silly mistake:P

[Author]

Replies