Self-Constructed Assets
E10-8 (Interest Capitalization)
On December 31, 2016, Main Inc. borrowed $3,000,000 at 12% payable annually to finance the
construction of a new building. In 2017, the company made the following expenditures related to
this building: March 1, $360,000; June 1, $600,000; July 1, $1,500,000; December 1,
$1,500,000. The building was completed in February 2018. Additional information is provided
as follows.
1. Other debt outstanding
10-year, 13% bond, December 31, 2010, interest payable annually $4,000,000
6-year, 10% note, dated December 31, 2014, interest payable annually $1,600,000
2. March 1, 2017, expenditure included land cost of $150,000
3. Interest revenue earned in 2017 $49,000
Instructions
(a) Determine the amount of interest to be capitalized in 2017 in relation to the construction
of the building.
(b) Prepare the journal entry to record the capitalization of interest and the recognition of
interest expense, if any, at December 31, 2017.
Solution
(a) Computation of Weighted-Average Accumulated Expenditures
Expenditures
Capitalization Weighted-Average Accumulated
Date Amount X Period = Expenditures
March 1 $ 360,000 10/12 $ 300,000
June 1 600,000 7/12 350,000
July 1 1,500,000 6/12 750,000
December 1 1,500,000 1/12 125,000
$3,960,000 $1,525,000
Computation of Avoidable Interest
Weighted-Average
Accumulated Expenditures X Interest Rate = Avoidable Interest
$1,525,000 .12 (Construction loan) $183,000
Actual interest
$3,000,000 X 12% $ 360,000
$4,000,000 X 13% 520,000
$1,600,000 X 10% 160,000
$1,040,000
Note: Use avoidable interest for capitalization purposes because it is lower than actual.
Constructions in Progress..............................................................................
183,000
(b)
Interest Expense*...........................................................................................
857,000
Cash ($360,000 + $520,000 + $160,000).......................................... 1,040,000
*Actual interest for year $1,040,000
Less: Amount capitalized 183,000
Interest expense debit $ 857,000
Exercise
Beluga Company began construction of a building on January 1, 2019. The company borrowed a
$500,000, 12% loan to finance the construction. Beluga made the following expenditures related
to the construction.
January 31: $450,000 June 1: $300,000 December 1: $150,000
Information related to other debt outstanding within the company is as follows. The company has
a $100,000, 14% note payable and a $50,000, 10% note payable.
Instructions
(a) Calculate the weighted average accumulated expenditures for interest capitalization
purposes.
(b) Calculate the weighted average interest rate for interest capitalization purposes.
(c) Calculate the avoidable interest for interest capitalization purposes.
(d) Calculate the actual interest for interest capitalization purposes.
(e) Determine whether the firm should capitalize avoidable or actual interest.
Solution
(a) Weighted average accumulated expenditures
(450,000 X 11/12) + (300,000 X 7/12) + (150,000 X 1/12) = $600,000
(b) Weighted average interest rate
$100,000 X 14% = $14,000
$50,000 X 10% = $5,000
Weighted average interest rate = (14,000 + 5,000) / (100,000 + 50,000) = 12.7%
(c) Avoidable interest
Weighted average accumulated expenditures = $600,000
Specific construction debt = $500,000
Difference = $600,000 - $500,000 = $100,000
Weighted average Interest rate Avoidable interest
accumulated expenditures
500,000 12% $60,000
100,000 12.7% 12,700
600,000 $72,700
(d) Actual Interest
12% construction loan = 500,000 X 12% = 60,000
14% note payable = 100,000 X 14% = 14,000
10% note payable = 50,000 X 10% = 5,000
Total interest expense = $79,000
(e) The firm should capitalize the lower of actual interest or avoidable interest. In this case,
avoidable interest is lower than actual interest and therefore the firm should capitalize
$72,700 of interest.
