[setmefree]

can someone help me out with this question. I am confused why the construction loan $300k don’t need to divide by 2 since its evenly outstanding the whole year?
I thought the answer is $15,000

A company obtained a $300,000 loan with a 10% interest rate on January 1, year 1, to finance the construction of an office building for its own use. Building construction began on January 1, year 1, and the project was not completed as of December 31, year 1. The following payments were made in year 1 related to the construction project:
January 1
Purchased land for $120,000
September 1
Progress payment to contractor for $150,000

What amount of interest should be capitalized for the year ended December 31, year 1?

$13,500

$15,000

$17,000

$30,000
You Answered Correctly!
Interest can be capitalized on the accumulated average expenditures during the year. During year 1 the weighted average expenditures were ($120,000 x 12/12) + ($150,000 x 4/12) = $170,000. Interest is capitalized based on the weighted average expenditures times the interest rate of 10% ($170,000 x .10 = $17,000).

[Williams]

The construction costs aren't incurred evenly throughout the year. Since the land was purchased in January the interest from that cost should be allocated throughout the whole year. However, the payment to the contractor occurred during September, therefore it is weighted for the four months of benefit it provided the asset. I hope this helps.

FYI when computing interest capitalization you use actual cost incurred. The amount of the construction loan($300k) is irrelevant.

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[setmefree]

@jnwilliams328
THank you

[kliseong]

Is the average WA expense calculation for this problem different from the one below bc this one is “payments” and the one below is just expenses not yet paid?

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. $132,000

c. $72,500

d. $60,000

[Anonymous]

@kliseong

Use WA as above

$200,000 (12/12) = 200,000
$600,000 (8/12) = 400,000
$300,000 (1/12) = 25,000

Total = $625,000

You calculate interest on construction loans FIRST so its the $500,000 constr. loan @ 12% = 60,000

Then the remaining 125,000 (625,000-500,000) would use the other loan's interest rate @ 10% = 12,500

Total Interest Capitalized = 72,500

[Author]

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