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To illustrate the issues related to interest capitalization, assume that on November 1, 2016, Shalla Company contracted Pfeifer Construction Co. to construct a building for $1,400,000 on land costing $100,000 (purchased from the contractor and included in the first payment). Shalla made the following payments to the construction company during 2017 January 1 S210,000 March 1 $300,000 May 1 $540,000 December 31 $450,000 Total $1,500,000 Pfeifer Construction completed the building, ready for occupancy, on December 31, 2017. Shalla had the following debt outstanding at December 31, 2017 $750,000 Specific Construction Debt 1. 15%, 3-year note to finance purchase of land and construction of the building, dated December 31, 2016, with interest payable annually on December 31 Other Debt 2. 10%, 5-year note payable, dated December 31, 2013, with interest payable annually on December 31 3. 12%, 10-year bonds issued December 31, 2012, with interest payable annually on December 31 $550,000 $600,000 Shalla computed the weighted-average accumulated expenditures during 2017 as shown in Illustration 10-4. Expenditures Date Amount January 1 $ 210,000 March 1 300,000 May 1 540,000 December 31 450,000 $1,500,000 Current-Year Capitalization Period 12/12 10/12 8/12 0 Weighted Average Accumulated Expenditures $210,000 250,000 360,000 0 $820,000 Note that the expenditure made on December 31, the last day of the year, does not have any interest cost. Shalla computes the avoidable interest as shown in Illustration 10-5. Interest Rate Avoidable Interest Weighted-Average Accumulated Expenditures X $750,000 70,000 $820,000 .15 (construction note) .1104 (weighted average of other debt) $112,500 7,728 $120.228 The amount by which the weighted average accumulated expenditures exceeds the specific construction loan. Weighted average interest rate computation: Principal Interest 10%, 5-year note $ 550,000 $ 55,000 12%, 10-year bonds 600,000 72,000 $1,150,000 $127.000 Weighted-average interest rate Total interest Total principal $127,000 $1,150,000 11.04% The company determines the actual interest cost, which represents the maximum amount of interest that it may capitalize during 2017, as shown in Illustration 10-6. Construction note 5-year note 10-year bonds Actual interest $750,000 x .15 - $112,500 550,000 X.10 - 55,000 600,000 X.12 = 72,000 $239,500 The interest cost that Shalla capitalizes is the lesser of $120,228 (avoidable interest) and $239,500 (actual interest), or $120,228. Shalla records the following journal entries during 2017: January 1 Land 100,000 Buildings (or Construction in Process) 110,000 Cash 210,000 March 1 300,000 Buildings Cash 300,000 May 1 540,000 Buildings Cash 540,000 450,000 450,000 December 31 Buildings Cash Buildings (Capitalized Interest) Interest Expense ($239,500 - $120,228) Cash ($112,500 + $55,000 + $72,000) 120.228 119,272 239,500 Shalla should write off capitalized interest cost as part of depreciation over the use- ful life of the assets involved and not over the term of the debt. It should disclose the total interest cost incurred during the period, with the portion charged to expense and the portion capitalized indicated. At December 31, 2017, Shalla discloses the amount of interest capitalized either as part of the nonoperating section of the income statement or in the notes accompanying the financial statements. We illustrate both forms of disclosure, in Illustrations 10-7 and 10-8.4 XXXX Income from operations Other expenses and losses: Interest expense Less: Capitalized interest Income before income taxes Income taxes Net income $239,500 120.228 119,272 XXXX XXX XXXX Note 1: Accounting Policies. Capitalized Interest. During 2017, total interest cost was $239,500, of which $120.228 was capitalized and $119,272 was charged to expense. To illustrate the issues related to interest capitalization, assume that on November 1, 2016, Shalla Company contracted Pfeifer Construction Co. to construct a building for $1,400,000 on land costing $100,000 (purchased from the contractor and included in the first payment). Shalla made the following payments to the construction company during 2017 January 1 S210,000 March 1 $300,000 May 1 $540,000 December 31 $450,000 Total $1,500,000 Pfeifer Construction completed the building, ready for occupancy, on December 31, 2017. Shalla had the following debt outstanding at December 31, 2017 $750,000 Specific Construction Debt 1. 15%, 3-year note to finance purchase of land and construction of the building, dated December 31, 2016, with interest payable annually on December 31 Other Debt 2. 10%, 5-year note payable, dated December 31, 2013, with interest payable annually on December 31 3. 12%, 10-year bonds issued December 31, 2012, with interest payable annually on December 31 $550,000 $600,000 Shalla computed the weighted-average accumulated expenditures during 2017 as shown in Illustration 10-4. Expenditures Date Amount January 1 $ 210,000 March 1 300,000 May 1 540,000 December 31 450,000 $1,500,000 Current-Year Capitalization Period 12/12 10/12 8/12 0 Weighted Average Accumulated Expenditures $210,000 250,000 360,000 0 $820,000 Note that the expenditure made on December 31, the last day of the year, does not have any interest cost. Shalla computes the avoidable interest as shown in Illustration 10-5. Interest Rate Avoidable Interest Weighted-Average Accumulated Expenditures X $750,000 70,000 $820,000 .15 (construction note) .1104 (weighted average of other debt) $112,500 7,728 $120.228 The amount by which the weighted average accumulated expenditures exceeds the specific construction loan. Weighted average interest rate computation: Principal Interest 10%, 5-year note $ 550,000 $ 55,000 12%, 10-year bonds 600,000 72,000 $1,150,000 $127.000 Weighted-average interest rate Total interest Total principal $127,000 $1,150,000 11.04% The company determines the actual interest cost, which represents the maximum amount of interest that it may capitalize during 2017, as shown in Illustration 10-6. Construction note 5-year note 10-year bonds Actual interest $750,000 x .15 - $112,500 550,000 X.10 - 55,000 600,000 X.12 = 72,000 $239,500 The interest cost that Shalla capitalizes is the lesser of $120,228 (avoidable interest) and $239,500 (actual interest), or $120,228. Shalla records the following journal entries during 2017: January 1 Land 100,000 Buildings (or Construction in Process) 110,000 Cash 210,000 March 1 300,000 Buildings Cash 300,000 May 1 540,000 Buildings Cash 540,000 450,000 450,000 December 31 Buildings Cash Buildings (Capitalized Interest) Interest Expense ($239,500 - $120,228) Cash ($112,500 + $55,000 + $72,000) 120.228 119,272 239,500 Shalla should write off capitalized interest cost as part of depreciation over the use- ful life of the assets involved and not over the term of the debt. It should disclose the total interest cost incurred during the period, with the portion charged to expense and the portion capitalized indicated. At December 31, 2017, Shalla discloses the amount of interest capitalized either as part of the nonoperating section of the income statement or in the notes accompanying the financial statements. We illustrate both forms of disclosure, in Illustrations 10-7 and 10-8.4 XXXX Income from operations Other expenses and losses: Interest expense Less: Capitalized interest Income before income taxes Income taxes Net income $239,500 120.228 119,272 XXXX XXX XXXX Note 1: Accounting Policies. Capitalized Interest. During 2017, total interest cost was $239,500, of which $120.228 was capitalized and $119,272 was charged to expense