(Interest During Construction) Grieg Landscaping began construction of a new plant on December 1, 2017. On this date, the company purchased a parcel of land for \(139,000 in cash. In addition, it paid \)2,000 in surveying costs and \(4,000 for a title insurance policy. An old dwelling on the premises was demolished at a cost of \)3,000, with \(1,000 being received from the sale of materials.

Architectural plans were also formalized on December 1, 2017, when the architect was paid \)30,000. The necessary building permits costing \(3,000 were obtained from the city and paid for on December 1 as well. The excavation work began during the first week in December with payments made to the contractor in 2018 as follows.

Date of Payment	Amount of Payment
March 1	\)240,000
May 1	330,000
July 1	60,000

The building was completed on July 1, 2018.

To finance construction of this plant, Grieg borrowed \(600,000 from the bank on December 1, 2017. Grieg had no other borrowings. The \)600,000 was a 10-year loan bearing interest at 8%.

Instructions

Compute the balance in each of the following accounts at December 31, 2017, and December 31, 2018. (Round amounts to the nearest dollar.)

1. Land.
2. Buildings.
3. Interest Expense.

Step by step solution

01

Meaning of Interest Expense

Interest expense is the amount accrued from borrowed fundssuch as loans or credits. Too much interest expense can cut into a company's profits.

02

(a) Computing balance of the land account

Calculating the amount of land

Particulars	Amounts ($)
Price	139,000
Survey Costs	2,000
Title Insurance Policy	4,000
Demolition Costs	3,000
Salvage of materials	(1,000)
Land Cost	$1,47,000

Therefore, the amount of land is $147,000

03

(b) Computing balance of building account

Calculating expenditure of 2017

Expense items	Amount	Capitalization period	Weighted average Accumulated expenditure
Land	$147,000	1/12 (month of 12/1/17)	$12,250
Architect	30,000	1/12	2,500
Permits	3,000	1/12	250
Totals	$180,000		$15,000

Calculation of Interest capitalized for 2017

$\begin{array}{rcl}\mathbf{Interest}\mathbf{}\mathbf{Capitalized}& \mathbf{=}& \mathbf{Weighted}\mathbf{}\mathbf{average}\mathbf{}\mathbf{accumulated}\mathbf{}\mathbf{expenditure}\mathbf{\times }\mathbf{Interest}\mathbf{}\mathbf{rate}\\ & \mathbf{=}& \mathbf{\$}\mathbf{15}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{0}\mathbf{.}\mathbf{08}\\ & \mathbf{=}& \mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{200}\end{array}$

Calculating the amount of building in 2017

Calculating the amount of building in 2018

Amount of building in 2017	$ 34,200
Payment made on March 1	240,000
Payment made on May 1	330,000
Payment made on July 1	60,000
Capitalizable amount	18,048
Amount of building in 2018	$682,248

04

(c) Computing balance of interest expense

Expenditure 2018
Date	Amount	Fraction	Weighted Expenditure
1-Jan	$180,000	6/12	$ 90,000
1-Jan	1,200	6/12	600
1-Mar	240,000	4/12	80,000
1-May	330,000	2/12	55,000
1-Jul	60,000	0	0
	$811,200		$225,600

Note: Amount on 1^st January is the total expenditure of 2017

Interest Capitalized for 2018

Weighted average Expenditure	Interest Rate	Amount Capitalizable
$225,600	8%	$18,048
Interest charged to Interest Expense $29,952

Working notes:

Calculation of interest expense in 2017

$\begin{array}{rcl}\mathbf{Interest}\mathbf{}\mathbf{expense}& \mathbf{=}& \left(\mathrm{Borrowed}\mathrm{amount}\times \mathrm{Interest}\mathrm{rate}\times \frac{\mathrm{Number}\mathrm{in}\mathrm{months}}{\mathrm{Month}\mathrm{in}a\mathrm{year}}\right)\mathbf{-}\mathbf{Capitalized}\mathbf{}\mathbf{Interest}\\ & \mathbf{=}& \left(\$600,000\times .08\times \frac{1}{12}\right)\mathbf{-}\mathbf{\$}\mathbf{12}\mathbf{,}\mathbf{000}\\ & \mathbf{=}& \mathbf{\$}\mathbf{4}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{200}\\ & \mathbf{=}& \mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{800}\end{array}$

Calculation of Interest expense in 2018

$\begin{array}{rcl}\mathbf{Interest}\mathbf{}\mathbf{Expense}& \mathbf{=}& \left(\mathrm{Borrowed}\mathrm{amount}\times \mathrm{Interest}\mathrm{rate}\right)\mathbf{-}\mathbf{Amount}\mathbf{}\mathbf{capitalization}\\ & \mathbf{=}& \left(\$600,000\times .08\right)\mathbf{-}\mathbf{\$}\mathbf{18}\mathbf{,}\mathbf{048}\\ & \mathbf{=}& \mathbf{\$}\mathbf{29}\mathbf{,}\mathbf{952}\end{array}$

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