Question

Vaughn Company is constructing a building. Construction began on February 1 and was completed on December 31. Expenditures were $1,968,000 on March 1, $1,248,000 on June 1 , and $3,046,000 on December 31. Vaughn Company borrowed $1,086,000 on March 1 on a 5-year, 12% note to help finance construction of the building. In addition, the company had outstanding all year a 9\%, 5-year, $2,448,000 note payable and an 10%,4-year, $3,546,000 note payable. Compute avoidable interest for Vaughn Company. Use the weighted-average interest rate for interest capitalization purposes.

Answer 1

The avoidable interest for Vaughn Company is $272,340.

Step-by-step explanation:

Vaughn Company capitalizes interest during the construction period as part of the cost of the building. To calculate avoidable interest, we use the weighted-average interest rate on outstanding debt. The formula for avoidable interest is:

`\[ \text{Avoidable Interest}\\ = \text{Weighted-Average Interest Rate} * \text{Weighted-Average Accumulated Expenditures} \}`

First, calculate the weighted-average interest rate:

`\[ \text{Weighted-Average Interest Rate} \\= \frac{(\text{Interest Rate} * \text{Principal}) + (\text{Interest Rate} * \text{Principal}) + (\text{Interest Rate} * \text{Principal})}{\text{Total Principal}} \]`

Substitute the values:

`\[ \text{Weighted-Average Interest Rate} = ((0.12 * 1,086,000) + (0.09 * 2,448,000) + (0.1 * 3,546,000))/(1,086,000 + 2,448,000 + 3,546,000) \]\[ \text{Weighted-Average Interest Rate} = (130,320 + 220,320 + 354,600)/(8,080,000) \]\[ \text{Weighted-Average Interest Rate} = (705,240)/(8,080,000) \]\[ \text{Weighted-Average Interest Rate} = 0.08725 \]`

Next, calculate the Weighted-Average Accumulated Expenditures:

`\[ \text{Weighted-Average Accumulated Expenditures} = ((1,968,000 * 11) + (1,248,000 * 8) + (3,046,000 * 0))/(11 + 8 + 0) \]\[ \text{Weighted-Average Accumulated Expenditures} = (21,648,000 + 9,984,000)/(19) \]\[ \text{Weighted-Average Accumulated Expenditures} = (31,632,000)/(19) \]\[ \text{Weighted-Average Accumulated Expenditures} = 1,664,842.11 \]`

Now, apply these values to the avoidable interest formula:

`\[ \text{Avoidable Interest} = 0.08725 * 1,664,842.11 \]\[ \text{Avoidable Interest} = 145,034.86 \]`

Therefore, the avoidable interest for Vaughn Company is $145,034.86.