Question

StellarFurniture Company started construction of a combination office and warehouse building for its own use at an estimated cost of $4,500,000 on January 1, 2020. Stellar expected to complete the building by December 31, 2020. Stellar has the following debt obligations outstanding during the construction period.

Construction loan-12% interest, payable semiannually, issued December 31, 2019 $1,800,000
Short-term loan-10% interest, payable monthly, and principal payable at maturity on May 30, 2021 1,350,000
Long-term loan-11% interest, payable on January 1 of each year. Principal payable on January 1, 2024 900,000

Required:
a. Assume that Stellar completed the office and warehouse building on December 31, 2020, as planned at a total cost of $11,440,000, and the weighted-average amount of accumulated expenditures was $7,920,000. Compute the avoidable interest on this project.
b. Compute the depreciation expense for the year ended December 31, 2021. Stellar elected to depreciate the building on a straight-line basis and determined that the asset has a useful life of 30 years and a salvage value of $660,000.

Answer 1

A. $852,480

B. $387,749

Step-by-step explanation:

1) Computation for the avoidable interest on this project

First step is to calculate the Avoidable interest on construction loan using this formula

Avoidable interest on construction loan = Loan Amount*Loan rate

Let plug in the formula

Avoidable interest on construction loan= $1,800,000*12%

Avoidable interest on construction loan= $216,000

Second step is to calculate the Weighted Average Interest Rate on General Loan (Amounts in $)

Loan Amount (A) Interest rate (B) Interest (A*B)

Short term loan 1,350,000 10% $135,000

Long term loan 900,000 11% 99,000

Total $2,250,000 $234,000

Weighted Average Interest rate = $234,000/$2,250,000

Weighted Average Interest rate = = 10.40%

Third step is to calculate the Avoidable Interest on Remaining Expenditure

Using this formula

Avoidable Interest on Remaining Expenditure

= (Weighted Average Accum. Exp - Construction Loan)*Weighted Avg interest rate

Let plug in the formula

Avoidable Interest on Remaining Expenditure= ($7,920,000 - $1,800,000)*10.40%

Avoidable Interest on Remaining Expenditure= $636,480

Now let calculate the Total Avoidable Interest

Total Avoidable Interest = $216,000+$636,480

Total Avoidable Interest= $852,480

Therefore the avoidable interest on this project

is $852,480

2) Computation for the depreciation expense for the year ended December 31, 2021.

First step is to calculate the Total cost of building capitalized

Total cost of building capitalized = $11,440,000+$852,480

Total cost of building capitalized = $12,292,480

Now let calculate the Depreciation Expense using this formula

Depreciation Expense = (Cost - Salvage Value)/Useful Life

Let plug in the formula

Depreciation Expense= ($12,292,480 - $660,000)/30 yrs

Depreciation Expense = $387,749 per year

Therefore the depreciation expense for the year ended December 31, 2021 is $387,749.