Question

Skysong Company is constructing a building. Construction began on February 1 and was completed on December 31. Expenditures were $3,960,000 on March 1, $2,640,000 on June 1, and $6,600,000 on December 31.

Skysong Company borrowed $2,200,000 on March 1 on a 5-year, 10% note to help finance construction of the building. In addition, the company had outstanding all year a 12%, 5-year, $4,400,000 note payable and an 11%, 4-year, $7,700,000 note payable.

Compute avoidable interest for Skysong Company. Use the weighted-average interest rate for interest capitalization purposes.

Answer 1

Weighted average accumulated expenditure:

March 1 = $3960000×10/12 =$3300000

June 1 =$2640000×7/12 =$1540000

Dec 31 =$7700000×0 =0

Total(3300000+1540000+0) =$4840000

Weighted average interest rate:

12%,5-year note×4400000=(4400000×12%) =$528000

11%,4-year note×7700000=(7700000×11%) =$847000

Total interest($528000+847000) =$1375000

Total principal(4400000+7700000) =$12100000

Weighted average interest rate = 1375000/12100000

=0.1136 (or) 11.36%

Computation of avoidable interest:

WAAE × interest rate = Avoidable interest

$2200000×10% =$220000

(4840000-2200000) ×11.36% = $299904

Total avoidable interest = (220000+299904) =$519904