Question

Turkey Incorporated began constructing a building on the 1st of January and completed construction on the 31st of December, of the same year. Costs on the construction at various points throughout this one-year period totaled $9,480. Assume the weighted average accumulated expenditures is $3,000. On January 1, Turkey borrowed $1,600 to finance the construction. They signed a 5-year, 12% note when they borrowed the money. Additional debt Turkey owed during the entire year included a 10%, 3-year, $1,000 note and an 11%, 4-year, $1,500 note. Round intermediate calculations to four decimals (e.g. 0.359782 rounds to 36.98%) and final answers to whole dollars. (a) What is the amount of avoidable interest? (17 points) (b) How much interest is capitalized for the year? Explain in words and calculations, how you made this decision. (9 points)

Answer 1

a) Avoidable interest will include interest on 5 year note taken to finance the construction and weighted average interest on the remaining accumulated expenditure (i.e. other than specific note amount). Weighted Average interest rate for general borrowing is calculated as follows:-

Calculation of Weighted Average Interest Rate (Amounts in $)

Loan	Amount (A)	Interest Rate (B)	Interest Expense (A*B)
3-year Note	1,000	10%	100
4-year Note	1,500	11%	165
Total	2,500		265

Weighted Average Interest rate = Total Interest/Total Loan

= $265/$2,500 = 0.106 or 10.60%

Calculation of Avoidable Interest (Amounts in $)

Interest on 5-year note (1,600*12%)	192
Weighted Average interest [(3,000-1,600)*10.60%]	148
Total Avoidable Interest	340

Therefore total avoidable interest is $340.

b) The interest to be capitalized is equal to interest expense on the amount used for construction during the construction period which is equal to avoidable interest.

The total avoidable interest of $340 is capitalized for the year.

Total interest expense = $192+$100+$165 = $457

Interest expensed = $457 - $340 = $117