Question

on january 1, 2025, waterway, inc. signed a fixed-price contract to have builder associates construct a major plant facility at a cost of $4,145,000. it was estimated that it would take 3 years to complete the project. also on january 1, 2025, to finance the construction cost, waterway borrowed $4,145,000 payable in 10 annual installments of $414,500, plus interest at the rate of 10%. during 2025, waterway made deposits and progress payments totaling $1,554,375 under the contract; the weighted-average amount of accumulated expenditures was $829,000 for the year. the excess borrowed funds were invested in short-term securities, from which waterway realized investment income of $270,000. what amount should waterway report as capitalized interest at december 31, 2025?

Answer 1

Waterway, Inc. should capitalize $82,900 as interest for the year ended December 31, 2025, which is the lesser of the actual effective interest cost of $144,500 (after adjusting for investment income) and the calculated avoidable interest on the weighted-average accumulated expenditures.

Step-by-step explanation:

To determine the capitalized interest for Waterway, Inc. for the year ended December 31, 2025, we must apply the guidance provided by applicable financial accounting standards. Capitalization of interest costs during the construction period allows companies to include those interest expenses as part of the asset's cost rather than charging them to expense in the period incurred. According to these standards, the capitalized interest is the lesser of the actual interest costs incurred during the period or the avoidable interest, which is the amount of interest cost that a company theoretically could avoid if it had not made expenditures for the asset.

The actual interest cost that Waterway incurred during 2025 can be calculated as the borrowed amount ($4,145,000) multiplied by the interest rate (10%), amounting to $414,500. However, since some of this money was invested and earned income, the effective interest cost would be reduced by the investment income. The effective interest cost is calculated by subtracting the investment income of $270,000 from the total interest cost incurred ($414,500) to get $144,500.

The avoidable interest is determined based on the weighted-average accumulated expenditures. For 2025, the weighted-average amount of accumulated expenditures is $829,000. Therefore, the avoidable interest is calculated by multiplying the weighted-average expenditures by the interest rate, which is $829,000 × 10% = $82,900.

Since the avoidable interest of $82,900 is less than the actual effective interest cost of $144,500, Waterway should capitalize $82,900, which is the lower amount, as part of the cost of the constructed asset.