A company constructs a building for its own use. Construction began on January 1 and ended on December 30. The expenditures for construction were as follows: January 1, $520,000; March 31, $620,000; June 30, $420,000; October 30, $660,000. To help finance construction, the company arranged a 9% construction loan on January 1 for $740,000. The company’s other borrowings, outstanding for the whole year, consisted of a $3 million loan and a $5 million note with interest rates of 10% and 6%, respectively. Assuming the company uses the specific interest method, calculate the amount of interest capitalized for the year.

Amount of interest capitalized is $108,975

Computation:

Accumulated Avg. Expense:

Expense for Construction(No. of Month / 12)

1 January  

$520,000(12 / 12) = $520,000  

31 March  

$620,000(9 / 12) = $465,000  

30 June    

$420,000(6 / 12) = $210,000  

30 October  

$660,000 (2 / 12) = $110,000  

Accumulated Avg. Expense = $1,305,000  

Interest on loan  = $3,000,000 × 10%

Interest on loan  = $300,000

Interest on note = $5,000,000 × 6%

Interest on note = $300,000

Total Value of Interest  = $300,000 + $300,000

Total Value of Interest  = $600,000

Total Amount of Loan = $3,000,000 + $5,000,000

Total Amount of Loan = $8,000,000

Weighted Avg. Interest Rate = $600,000 / $8,000,000

Weighted Avg. Interest Rate = 7.5%

Amount of Interest Capitalization = $740,000 × 9%

Amount of Interest Capitalization = $66,600

Excess Borrowing = $1,305,000 - $740,000  

Excess Borrowing = $565,000

Interest on Excess Borrowing = $565,000 × 7.5%

Interest on Excess Borrowing= $42,375

Capitalized Interest = $42,375 + $66,600

Capitalized Interest  = $108,975  

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$108,975

Explanation:

According to the scenario, computation of the given data are as follow:-

We need to do following calculations

Average Accumulated Expenditures:-

Expenditures for Construction × (Number of Month ÷ Total Month)

1 January   $520,000 × (12 ÷ 12) = $520,000

31 March   $620,000 × (9 ÷ 12) = $465,000

30 June     $420,000 × (6 ÷ 12) = $210,000

30 October  $660,000 × (2 ÷ 12) = $110,000

Total Average Accumulated Expenditures = $1,305,000  

Now

Weighted Average Interest Rate is

= Total Amount of Loan × Total Value of Interest  

= $3,000,000 × 10%

= $300,000

$5,000,000 × 6%

= $300,000

Total  Amount of  Loan is

= $3,000,000 + $5,000,000

= $8,000,000

Total  Value of Interest

= $300,000 + $300,000

= $600,000

Weighted Average Interest Rate is

= Total Value of Interest ÷  Total Amount of Loan  

= $600,000 ÷ $8,000,000

= 0.075

= 7.5%

Amount of Interest Capitalization= is

Specific Borrowing Interest = $740,000 × 9% = $66,600

Excess Borrowing = (Total Average Accumulated Expenditures - Specific Borrowing)

= $1,305,000 - $740,000

= $565,000

Interest on Excess Borrowing = Excess Borrowing × Weighted Average Interest Rate

= $565,000 × 7.5%

= $42,375

Capitalized Interest = Excess Interest Borrowing + Specific Borrowing Interest

= $42,375 + $66,600

= $108,975    

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