Chapter 10, Problem 10.9P

1.

To determine

Interest Capitalization:

Interest capitalization refers to the interest amount that is added to the cost of the long-term asset. Such interest capitalization amount includes the interest amount of the debt which was financed for acquiring the asset.

To Calculate: The amount of interest that Company M should capitalize in 2016 and 2017 using the specific interest method.

Explanation of Solution

Calculate the amount of interest capitalized in the year 2016.

Month	Construction Expenditure ($)		Interest Outstanding (Number of months)		Accumulated Expenditure ($)
January 1, 2016	100,000	$\times$	$\frac{12}{12}$	=	1,000,000
March 1, 2016	600,000	$\times$	$\frac{10}{12}$	=	500,000
June 30, 2016	800,000	$\times$	$\frac{6}{12}$	=	400,000
October 1, 2016	600,000		$\frac{3}{12}$	=	150,000
Accumulated expenditures (before interest)	$3,000,000
			Average accumulated expenditures		$2,050,000

Table (1)

Determine the capitalized interest.

$\begin{array}{c}\text{Capitalized}\text{interest = }\left(\begin{array}{l}\text{Accumulated expenditure}\\ \times \text{ Interest rate }\end{array}\right)\\ =\$2,050,000\times \frac{10}{100}\\ =\$205,000\end{array}$

Calculate the amount of interest capitalized in the year 2017.

Month	Construction Expenditure		Interest Outstanding		Accumulated Expenditure
January 1, 2017	3,205,000	$\times$	$\frac{9}{9}$	=	3,205,000
January 31, 2017	270,000	$\times$	$\frac{8}{9}$	=	240,000
April 30, 2017	585,000	$\times$	$\frac{5}{9}$	=	325,000
August 31, 2017	900,000	$\times$	$\frac{1}{9}$	=	100,000
Accumulated expenditures (before interest)	4,960,000
			Average accumulated expenditure		3,870,000

Table (2)

Determine the weighted average rate of all other debt.

	Amount ($)		Interest rate		Interest Amount ($)
Long-term note 6%	$4,000,000	$\times$	6%	=	240,000
Long-term note 8%	$6,000,000	$\times$	8%	=	480,000
Total	$10,000,000				720,000

Table (3)

Working Note:

Determine the weighted-average interest rate.

$\begin{array}{c}\text{Weighted average =}\frac{\text{Interest amount}}{\text{Amount}}\times 100\\ \text{=}\frac{\text{\$720,000}}{\$10,000,000}\times 100\\ =7.2\%\end{array}$

Determine the amount of difference.

$\begin{array}{c}\text{Amount of difference = }\left(\begin{array}{l}\text{Average accumulated expenditure}\\ \text{– Construction loan }\end{array}\right)\\ \text{= \$3,870,000 – \$3,000,000}\\ \text{=\$870,000}\end{array}$

Determine the interest on amount of difference.

$\begin{array}{c}\text{Interest on amount of difference = \$870,000 }\times \text{ 7}\text{.2\%}\times \frac{9}{12}\\ =\$46,980\end{array}$

Determine the interest on amount on the construction loan.

$\begin{array}{c}\text{Interest on amount on the construction loan = \$3,000,000 }\times \frac{\text{10}}{\text{100}}\times \frac{9}{12}\\ =\$225,000\end{array}$

Determine the capitalized interest.

$\begin{array}{c}\text{Capitalized}\text{interest = }\left(\begin{array}{l}\text{Interest on connstruction loan}\\ \text{+ Interest on amount}\end{array}\right)\\ =\$225,000+\$46,980\\ \text{= \$271,980}\end{array}$

Conclusion

Hence, the amount of interest capitalized in the year 2016, and 2017 are $205,000, and $271,980 respectively.

2.

To determine

The total cost of the building.

Explanation of Solution

Determine the total cost of the building.

Particulars	Amount ($)
Accumulated expenditures as on September 30, 2017 before interest capitalization	4,960,000
Add: Interest capitalization as on 2017	271,980
Total cost of building	5,231,980

Table (4)

Conclusion

Hence, the total cost of the building is $5,231,980.

3.

To determine

To Calculate: The amount of interest expense that will appear in the 2016 and 2017 income statements.

Explanation of Solution

Calculate the amount of interest expense for 2016 and 2017.

	2016	2017
	Amount ($)	Amount ($)
$\$3,000,000\times 10\%$	300,000	300,000
$\$4,000,000\times 6\%$	240,000	240,000
$\$6,000,000\times 8\%$	480,000	480,000
Total interest capitalized	1,020,000	1,020,000
Less: Interest capitalized	(205,000)	(271,980)
Interest expense	815,000	748,020

Table (5)

Conclusion

Hence, the amount of interest expense that will appear in the income statement for the years 2016 and 2017 are $815,000 and $748,020 respectively.