(Capitalization of Interest) On July 31, 2017, Amsterdam Company engaged Minsk Tooling Company to construct a special-purpose piece of factory machinery. Construction was begun immediately and was completed on November 1, 2017. To help finance construction, on July 31 Amsterdam issued a \(300,000, 3-year, 12% note payable at Netherlands National Bank, on which interest is payable each July 31. \)200,000 of the proceeds of the note was paid to Minsk on July 31. The remainder of the proceeds was temporarily invested in short-term marketable securities (trading securities) at 10% until November 1. On November 1, Amsterdam made a final \(100,000 payment to Minsk. Other than the note to Netherlands, Amsterdam’s only outstanding liability at December 31, 2017, is a \)30,000, 8%, 6-year note payable, dated January 1, 2014, on which interest is payable each December 31.

Instructions

(a) Calculate the interest revenue, weighted-average accumulated expenditures, avoidable interest, and total interest cost to be capitalized during 2017. (Round all computations to the nearest dollar.)

(b) Prepare the journal entries needed on the books of Amsterdam Company at each of the following dates.

(1) July 31, 2017.

(2) November 1, 2017.

(3) December 31, 2017.

Step by step solution

01

Meaning of Capitalization of Interest

As with other interests, capitalized interest accumulates on an asset or loan, but it is not immediately recognized as an expense on the income statement. The accrued interest is instead deducted from the asset's value on the income statement, which includes the interest in its total value on the balance sheet.

02

(a) Calculation of weighted-average accumulated expenditure

Expenditures
Date Amount Capitalization Period	Weighted-Average Accumulated Expenditures
July 31 $200,000 3/12	$50,000
November 1 100,000 0	0
	$50,000

Calculation of interest revenue

$Interestrevenue=Amount\times Securitiesrate\times Captilalizationperiod$

$=\$200,000\times 10℅\times \frac{3}{12}$

$=\$2,500$

Computation of avoidable interest

$Avoidable=WeightedAverage\times Interestrate$

$=\$50,000\times 12℅$

$=\$6,000$

Computation of Actual Interest
Calculation	Actual Interest
$\$3,000,000\times 12℅\times \frac{5}{12}$	$15,000
$\$30,000\times 8℅$	2,400
	$17,400

The interest capitalized is $6,000.

03

(b1) Preparing journal entry

Date	Particulars	Debit ($)	Credit ($)
Jul. 31, 2017	Cash	300,000
	Notes Payable		300,000
Jul. 31, 2017	Machinery	200,000
	Trading Securities	100,000
	Cash		300,000

04

(b2) Preparing journal entry

Date	Particulars	Debit ($)	Credit ($)
Nov. 1, 2017	Cash	102,500
	Interest Revenue		2,500
	Trading Securities		100,000
Nov. 1, 2017	Machinery	100,000
	Cash		100,000

Working Notes:

Calculation of interest revenue

$Interestrevenue=Amount\times Securitiesrate\times Captilizationperiod$

$=\$200,000\times 10℅\times \frac{3}{12}$

$=\$2,500$

05

(b3) Preparing journal entry

Date	Particulars	Debit ($)	Credit ($)
Dec. 31, 2017	Machinery	6,000
	Interest Expense	11,400
	Cash		2,400
	Interest Payable		15,000

Working notes:

Calculation of interest payable

$Interestpayable=Issuednotepayable\times Securitiesrate\times Capitalizationperiod$

$=\$3000,000\times 12℅\frac{5}{12}$

$=\$15,000$

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