Question

On January 1, 2024, the Mason Manufacturing Company began construction of a building to be used as its office headquarters. The building was completed on September 30, 2025. Expenditures on the project were as follows:

January 1, 2024 $ 1,080,000
March 1, 2024 900,000
June 30, 2024 320,000
October 1, 2024 700,000
January 31, 2025 720,000
April 30, 2025 1,035,000
August 31, 2025 1,800,000
On January 1, 2024, the company obtained a $3 million construction loan with a 10% interest rate. Assume the $3 million loan is not specifically tied to construction of the building. The loan was outstanding all of 2024 and 2025. The company’s other interest-bearing debt included two long-term notes of $5,000,000 and $7,000,000 with interest rates of 5% and 8%, respectively. Both notes were outstanding during all of 2024 and 2025. Interest is paid annually on all debt. The company’s fiscal year-end is December 31.

Required:
Using the weighted-average interest method, answer the following questions:

Calculate the amount of interest that Mason should capitalize in 2024 and 2025 using the weighted-average method.
What is the total cost of the building?
Calculate the amount of interest expense that will appear in the 2024 and 2025 income statements.

Answer 1

Step-by-step explanation:

To calculate the amount of interest that Mason should capitalize, we need to first determine the weighted-average interest rate. We can do this by multiplying the interest rate of each debt by its respective outstanding balance and summing the products. Then we divide the total interest by the total outstanding debt to obtain the weighted-average interest rate.

Weighted-average interest rate for 2024:

Interest on construction loan = $3,000,000 x 10% = $300,000

Interest on $5,000,000 note = $5,000,000 x 5% = $250,000

Interest on $7,000,000 note = $7,000,000 x 8% = $560,000

Total interest = $300,000 + $250,000 + $560,000 = $1,110,000

Total outstanding debt = $3,000,000 + $5,000,000 + $7,000,000 = $15,000,000

Weighted-average interest rate = $1,110,000 ÷ $15,000,000 = 7.4%

Weighted-average interest rate for 2025:

Interest on construction loan = $3,000,000 x 10% = $300,000

Interest on $5,000,000 note = $5,000,000 x 5% = $250,000

Interest on $7,000,000 note = $7,000,000 x 8% = $560,000

Total interest = $300,000 + $250,000 + $560,000 = $1,110,000

Total outstanding debt = $3,000,000 + $5,000,000 + $7,000,000 = $15,000,000

Weighted-average interest rate = $1,110,000 ÷ $15,000,000 = 7.4%

Using the weighted-average interest rate of 7.4%, we can now calculate the amount of interest that should be capitalized each year:

Interest capitalized in 2024:

Weighted-average interest rate = 7.4%

Weighted-average amount of expenditures = (($1,080,000 x 9/12) + ($900,000 x 9/12) + ($320,000 x 6/12) + $700,000) = $2,620,000

Interest capitalized = $2,620,000 x 7.4% = $193,240

Interest capitalized in 2025:

Weighted-average interest rate = 7.4%

Weighted-average amount of expenditures = ($720,000 + $1,035,000 + ($1,800,000 x 3/12)) = $3,315,000

Interest capitalized = $3,315,000 x 7.4% = $245,460

To calculate the total cost of the building, we need to add up all the expenditures incurred during the construction period:

Total cost of building = $1,080,000 + $900,000 + $320,000 + $700,000 + $720,000 + $1,035,000 + $1,800,000 = $6,555,000

To calculate the amount of interest expense that will appear in the 2024 and 2025 income statements, we need to use the following formula:

Interest expense = Weighted-average interest rate x Total outstanding debt

Interest expense in 2024:

Interest expense = 7.4% x $15,000,000 = $1,110,000

Interest expense in 2025:

Interest expense = 7.4% x $15,000,000