Ch10 Part2

# Hokie may either use the weighted average interest

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Hokie may either use the weighted-average interest rate on all of its debt or it may use the specific interest method.

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10-10 Interest Capitalization What would Hokie do if it used the specific interest method and specific new borrowing was insufficient to cover the average accumulated expenditures? What would Hokie do if it used the specific interest method and specific new borrowing was insufficient to cover the average accumulated expenditures? Assume that Hokie borrowed \$250,000 on May 1 for 10 years at a 10% interest rate specifically to finance construction. Hokie also has two other long-term notes outstanding that are not related to the construction project. The principal of these notes is \$500,000 and \$300,000 with interest rates of 13.2% and 10%, respectively. Both notes were outstanding during the entire construction period. Assume that Hokie borrowed \$250,000 on May 1 for 10 years at a 10% interest rate specifically to finance construction. Hokie also has two other long-term notes outstanding that are not related to the construction project. The principal of these notes is \$500,000 and \$300,000 with interest rates of 13.2% and 10%, respectively. Both notes were outstanding during the entire construction period.
10-11 Interest Capitalization Hokie can use the specific borrowing rate of 10 percent on average accumulated expenditures up to \$250,000. Hokie must use the weighted-average interest rate on average accumulated expenditures that exceed \$250,000. The amount of interest capitalized would be calculated as follows: \$250,000 × 10% × 8/12 = \$16,667 (\$337,500 – \$250,000) × 12% × 8/12 = \$7,000 Total capitalized interest = \$16,667 + \$7,000 = \$23,667* *Must not exceed actual interest incurred.

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10-12 Interest Capitalization What if Hokie did not complete construction of the building on December 31? Assume that construction continues for another 5 months and the building is completed on May 31 st of the second year. As in the previous example, assume that Hokie borrowed \$250,000 on May 1 (year 1) for 10 years at a 10% interest rate specifically to finance construction. Hokie also has two other long-term notes outstanding that are not related to the construction project. The principal of these notes is \$500,000 and \$300,000 with interest rates of 13.2% and 10%, respectively. Both notes were outstanding during the entire construction period.
10-13 Interest Capitalization Hokie incurred the following qualifying expenditures in year 2: March 1, \$100,000 and May 1, \$200,000. Average Accumulated Expenditures Fraction of Construction Date Expenditure Period AAE 1/1 808,667 \$ 5/5 808,667 \$ 3/1 100,000 3/5 60,000 5/1 200,000 1/5 40,000 1,108,667 \$ 908,667 \$ * Represents the total cost of the building as of December 31, year 1. Calculated by adding the total construction expenditures incurred in year 1 (\$785,000 – from slide 5) plus the interest capitalized in year 1 (\$23,667 from slide 11).

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