During 2014, Barden Building Company constructed various assets at a total cost

Question

During 2014, Barden Building Company constructed various assets at a total cost of $12,600,000. The weighted average accumulated expenditures on assets qualifying for capitalization of interest during 2014 were $8,400,000. The company had the following debt outstanding at December 31, 2014:

1.   10%, 5-year note to finance construction of various assets,

      dated January 1, 2014, with interest payable annually on January 1                     $5,400,000

2.   12%, ten-year bonds issued at par on December 31, 2008, with interest

      payable annually on December 31 $6,000,000

3.   9%, 3-year note payable, dated January 1, 2013, with interest payable

      annually on January 1 $3,000,000

Instructions

Compute the amounts of each of the following (show computations).

1.   Avoidable interest.

2.   Total interest to be capitalized during 2014.

Explanation / Answer

Weighted Average Accumulated Expenditure on Assets = $8,400,000. Out of this $8,400,000, $5,400,000 is financed by 10%, 5 Year Note. The rest i.e. $3,000,000 is financed out of the general loans. The interest rate on specific loan is 10% while the weighted interest rate on the general loans is calculated below: Loan Principal Rate Annual Interest 12%, Ten Year Bonds $6,000,000 12% 720,000 9%, 3 Year Notes Payable $3,000,000 9% 270,000 9,000,000 990,000 Weighted Average Interest rate = 990000 / 9000000 = 11% The above calculations furnish us with all the data needed to arrive at an estimate of avoidable interest Funding Amount Rate Avoidable Interest Specific Loan $5,400,000 10% 540,000 General pool $3,000,000 11% 330,000 870,000 This $8,70,000 is the amount of interest that could have been avoided. This much interest can be capitalized provided it doesn’t exceed the actual interest expense for the period. Avoidable Interest = $870000 Total Interest to be Capitalized = $870000

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