[Felecia]

Hello All! Please help me to understand this (what seems to be) inconsistency.

A company with a June 30 fiscal year end entered into a $3,000,000 construction project on April 1 to be completed on September 30. The cumulative construction-in-progress balances at April 30, May 31, and June 30 were $500,000, $800,000, and $1,500,000 respectively. The interest rate on company debt used to finance the construction project was 5% from April 1 through June 30 and 6% from July through September 30. Assuming that the asset is placed into service on October 1, what amount of interest should be capitalized to the project on June 30?

When this project began, there were only 3 months left in the period (April 1 – June 30 = 3 months). When attempting to find the weighted average of expenditures (the part that must be figured out before we can solve for capitalized interest), I used the same reasoning that I use in other problems that require determination of weighted average expenditures. Why doesn’t it work here? As my calculation illustrates, the numerator is reflective the portion of the period that the expenditure existed. The denominator is reflective of the number of months from project begin til year end.
(500,000 x 3/3) + (300,000 x 2/3) + (700,000 x 1/3) =

500,000 + 200,000 + 233,333 = 933,333 (weighted average expenditures)
933,333 x .05 = 46,666 (Capitalized interest)

My answer of 46,666 is incorrect. The correct answer is 11,666. But how??

[Mookie]

Calculate weighted average of expense

500*(3/12)+300*(2/12)+700*(1/12) = 233,333

Then multiply this by your interest rate (5%)

233,333*.05= 11,666

Remember that even though they have a year end of 6/30, the weighted average will use a calendar year. So the denominator is 12 in our calculation.

[Felecia]

Thank you Mookie.

[Felecia]

Why are we not using 12 (months) as the denominator when determining weighted average expenditures for this question? What makes the difference?

[Felecia]

Fountain Co. is constructing an office building for its own use. Fountain started the two-year construction project on April 1, Year 1, at which point the interest capitalization period began. Fountain made the following payments in Year 1 related to the construction of the building:

[Felecia]

I apologize for trying to send this question in sections. I am new to the forum, and I keep getting error messages.

[TARIK]

Avoidable interest equals $933,333 × 5% (3/12), or $11,666.

[Author]

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