Can someone help explain this simulation on capitalized construction costs? I know that the rule is that you capitalize the lesser of actual interest expense or WA Expenditures * interest rate. I just can't seem to wrap my head around how this is applied on the following simulation:
Cougar Co. built a warehouse during Year 2 and Year 3. The following payments were made during construction for building materials, labor, and overhead:
January 1, Year 2 April 1, Year 2 October 1, Year 2 January 15, Year 3
$130,000 $240,000 $200,000 $350,000
In addition, Cougar:
• borrowed $300,000 at 12% on January 1, Year 2, under a construction note.
• had bonds outstanding of $100,000 at 10% on January 1, Year 2; interest is payable annually on December 31.
• had notes payable outstanding of $300,000 at 7% on January 1, Year 2; interest is payable annually on December 31.
• completed construction on the building, which was ready for immediate use on March 1, Year 3.
Items Amount
The weighted-average accumulated expenditures for Year 2 $ 360,000
The interest incurred for all borrowings for Year 2 $ 67,000
The avoidable interest for Year 2 $ 40,650
The interest capitalized for Year 2 $ 40,650
The interest expense for Year 2 $ 26,350
The long-term construction of a warehouse for company use as a discrete project qualifies for interest capitalization. The costs expended in the building process have to be estimated as weighted-average accumulated expenditures for a principal amount for interest cost capitalization. This involves assessing how much was expended in the building process over the year in question.
Expenditures Part of Year 2
$130,000 × 12/12 = $130,000 January to December
$240,000 × 9/12 = 180,000 April to December
$200,000 × 3/12 = 50,000 October to December
Weighted-average
accumulated expenditures = $360,000
The last amount was paid in Year 3, and does not affect Year 2.
The interest rate to figure out the interest cost to capitalize is based specifically on construction-related debt if there is more of it than the weighted-average accumulated expenditures. The weighted-average accumulated expenditures are $360,000 and the specific construction-related debt is only $300,000. The additional $60,000 is applied as principal to a blended rate based on the remaining debt outstanding.
The company has only $300,000 of specific construction-related debt paying 12%. The other debt is as follows:
• The company has bonds of $100,000 paying 10% interest, or $10,000 each year.
• The company has notes of $300,000 paying 7% interest, or $21,000 each year.
• The blended rate for the other debt is based on the total interest and principal: $10,000 + $21,000 = Total interest of $31,000. $100,000 + $300,000 = $400,000 total principal. The blended rate for the additional $60,000 is $31,000 ÷ $400,000, or 7.75%.
So, the “avoidable interest” on construction is the first $300,000 of the $360,000 of weighted-average accumulated expenditures at the specific debt-related interest rate. The additional $60,000 is multiplied by the blended rate of 7.75%.
$300,000 × .12 = $36,000
$60,000 × .0775 = 4,650
Total avoidable interest = $40,650
The total interest on all borrowings this year is:
$300,000 × .12 = $36,000
$100,000 × .10 = 10,000
$300,000 × .07 = 21,000
Total actual interest incurred = $67,000
The capitalized interest is the lower of the avoidable or actual interest, $40,650 (the avoidable). The remaining interest is an expense: $67,000 − $40,650 = $26,350.
(The references for this question are sections 2213.19–.23 and .26–.35 in the Financial Accounting and Reporting Reference Volume.)
FASB ASC 835-20-25-2 and 25-3; FASB ASC 835-20-30-2 through 30-6
FAR: 85(11/22/2014) - Becker(full)/Ninja MCQ (5 day cram)
AUD: 79 (2/1/2015) -Becker/Ninja MCQ/Ninja Notes
REG: 84(4/19/2015) -Becker/Ninja MCQ/Ninja Notes
BEC: 83 (7/13/2015) -Becker/Ninja MCQ/Ninja Notes
Date I Got My Life Back!: 8/4/2015 🙂
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