Ex 10-7 (Capitalization of Interest)

McPherson Furniture Company started construction of a combination office and warehouse building for its own use at an estimated cost of $5,000,000 on January 1, 2012. McPherson expected to complete the building by December 31, 2012. McPherson has the following debt obligations outstanding during the construction period: Construction loan - 12% interest, payable semiannually, issued 12/31/11 Short-term loan - 10% interest, payable monthly, and principle payable at maturity on May 30, 2013 Long-term loan - 11% interest, payable on January 1 of each year; principal payable on January 1, 2016 $ 2,000,000 1,600,000

1,000,000

(a) Assume the McPherson completed the office building and warehouse building on 12/31/12, as planned at a total cost of $5,200,000, and weighted average of accumulated expenditures was $3,800,000. Compute the avoidable interest for this project.

(b) Compute the depreciation expense for the year ended December 31, 2013. McPherson 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 $300,000

Ex 10-7 (Capitalization of Interest)

McPherson Furniture Company started construction of a combination office and warehouse building for its own use at an estimated cost of $5,000,000 on January 1, 2012. McPherson expected to complete the building by December 31, 2012. McPherson has the following debt obligations outstanding during the construction period: Construction loan - 12% interest, payable semiannually, issued 12/31/11 Short-term loan - 10% interest, payable monthly, and principle payable at maturity on May 30, 2013 Long-term loan - 11% interest, payable on January 1 of each year; principal payable on January 1, 2016 $ 2,000,000 1,600,000

1,000,000

(a) Assume the McPherson completed the office building and warehouse building on 12/31/12, as planned at a total cost of $5,200,000, and weighted average of accumulated expenditures was $3,800,000. Compute the avoidable interest for this project.

Calculation of Avoidable Interest

Weighted Average Avoidable Accumulated Expenditures Rate Interest Interest 2,000,000 12.00% 10.38% 240,000 186,840

Calculate interest on loan specifically for construction

Calculate interest on remaining loan up to weighted average 1,800,000 expenditures total using "weighted average" rate

TOTALS

3,800,000

$ 426,840

Weighted Average Rate for non-specific loans Type Short-term loan Long-term loan Total Amount Rate 1,600,000 1,000,000 2,600,000 Interest 10.00% 160,000 11.00% 110,000 270,000

Weighted Average Rate 270,000 2,600,000

10.38%

Ex 10-7 (Capitalization of Interest)

McPherson Furniture Company started construction of a combination office and warehouse building for its own use at an estimated cost of $5,000,000 on January 1, 2012. McPherson expected to complete the building by December 31, 2012. McPherson has the following debt obligations outstanding during the construction period: Construction loan - 12% interest, payable semiannually, issued 12/31/11 Short-term loan - 10% interest, payable monthly, and principle payable at maturity on May 30, 2013 Long-term loan - 11% interest, payable on January 1 of each year; principal payable on January 1, 2016

(a) Assume the McPherson completed the office building and warehouse building on 12/31/12, as planned at a total cost of $5,200,000, and weighted average of accumulated expenditures was $3,800,000. Compute the avoidable interest for this project.

Calculation of Avoidable Interest Calculate interest on loan specifically for construction Calculate interest on remaining loan up to weighted average expenditures total using "weighted average" rate

Weighted Average Avoidable Accumulated Expenditures Rate Interest Interest 2,000,000 1,800,000 12.00% 10.38% 240,000 186,840

TOTALS

3,800,000

426,840

Weighted Average Rate for non-specific loans Type Short-term loan Long-term loan Total Amount 1,600,000 1,000,000 2,600,000 Rate 10.00% 11.00% Interest 160,000 110,000 270,000

Weighted Average Rate

270,000 2,600,000

10.38%

(b) Compute the depreciation expense for the year ended December 31, 2013. McPherson 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 $300,000 - Must capitalize construction period interest (meaning interest is included as part of Building cost) To determine the amount to capitalize take the lesser of (1) actual interest paid or (2) avoidable interest (from (a) above)

Calculation of Actual Interest Paid Type Construction loan Short-term loan Amount 2,000,000 1,600,000 Rate 12.00% 10.00% Actual Interest 240,000 160,000

Long-term loan Total

1,000,000 4,600,000

11.00%

110,000 510,000

Compare Actual Interest to Avoidable Interest Actual Interest Paid 510,000 Avoidable Interest (from above) 426,840 use in building cost since lower amount

Therefore, Building Cost is: Cost of Construct Capitalized Interest Total Cost 5,200,000 426,840 5,626,840

Total Cost Less: Salvage Value Depreciable Base

5,626,840 300,000 5,326,840

Depreciation Expense =

5,326,840 30

Depreciation Expense =

177,561

2,000,000 1,600,000

1,000,000