Accounting 302 Chapter 10 Interest Capitalization In-Class Problem

Accounting 302 Chapter 10 Interest Capitalization In-class problem

SOLUTION

ACE started the building of a new corporate headquarters on Feb. 1, 2000—so interest cap. period begins on 2/1/2000. During the first year (on 7/1/2000) a construction loan for the building was taken out. During the entire construction period the company had outstanding debt consisting of (1) $10M, 6% bond issue and (2) $7M, 5% bond issue. [The weighted average % of “all other” debt = (600k + 350k) / 17,000k = 0.0558823]

Since the specific construction loan was not outstanding for the entire period 2/1 – 12/30/2000, we have to calculate AAE and IPC for two sub-periods in 2000.

(A) 2/1-7/1 (5 months):

AAE::$1.0M * 5/5 = $1.0M

$2.5M * 3/5 = $1.5 M

$2.5M

IPC = $2.5M * (5/12 * 0.0558823) = $58,211

(B) 7/1-12/30 (6 months)

AAE::$3.5M * 6/6 = $3.50M(why not $2.5M?)

$3.2M * 5/6 = $2.66 M

$5.0M * 1/6 = $0.83 M

$7.00 M

IPC = $7.0M * (6/12 * 0.10) = $350,000

Actual interest in 2000 = $950,000 + 500,000 = $1,450,000

Total interest potentially capitalizable = 350,000 + $58,211 = $408,211

Interest capitalized = $ 408,211.

Interest expensed = $1,041,789.

For 2001:

AAE

Jan.1, 2001 ($11,700,000 + 408,211) * 12/12 = $12,108,211

Jan.1 through Dec.31, 2001

(evenly) $12,000,000 * 0.5 = $ 6,000,000

AAE (2001) = $18,108,211

Interest potentially capitalizable (interest avoidable):

$10,000,000 * 0.10 = $1,000,000

$ 8,108,211 * 0.0558823 = $ 453,105

Total IPC = $1,453,105

Actual interest = $950,000 + $1,000,000 = $1,950,000

Interest capitalized for 2001 = $1,453,105.

Interest expensed = $496,895.

For 2002:

AAE

Jan.1, 2002 ($24,108,211 + $1,453,105) * 6/6 = $25,561,316.

Apr.1 $750,000 * 3/6 = 375,000

July 1 2,300,000 * 0/6 = 0 .

AAE (2002) = $25,936,316.

Interest potentially capitalizable (interest avoidable):

$10,000,000 * (0.10 * 6/12) = $500,000

$15,936,316* (0.0558823 * 6/12) = $445,279

Total IPC = $945,279

Actual interest for construction period= $475,000 + $500,000 = $975,000

Actual interest for the year = $950,000 + $666,667 = $1,616,667

Interest capitalized for 2002 = $945,279.

Interest expensed = $671,388.

Accounting 302 L.DuCharme Chapter10—Interest Capitalization: Self-constructed Assets page 1