Borrowing Costs

Assignment

1. On 1st May 20x1, Roger took a loan of Php 1,000,000 from a bank at the annual interest rate of 5%. The
purpose of this loan was to finance a construction of a production hall. The construction started on June 1
20x1. Roger temporarily invested Php 800,000 borrowed money during the months of June and July 20x1 at
the rate of 2% p.a.

What borrowing cost can be capitalized in 20x1?

Answer: (1M x 5% x 7/12*) – (800,000 x 2% x 2/12) = 26,500

*Although the funds were withdrawn on 1st May, the capitalization can start only on 1st June 20X1 when all criteria were met (the
construction had not started until 1st June).

2. During 20x2, Roger Co. constructed a new manufacturing facility at a cost of Php 12,000,000. The
weighted average accumulated expenditures for 20x2 were calculated to be Php 5,400,000. The company
had the following debt outstanding at December 31, 2002:

a. 10 percent, five-year note to finance construction of the manufacturing facility, dated

January 1, 2002, Php 3,600,000

b. 12 percent, 20-year bonds issued at par on April 30, 20x1, Php 8,400,000

c. 8 percent, six-year note payable, dated March 1, 20x1, Php 1,800,000

Determine the amount of interest to be capitalized by Roger for 20x2.

Capitalization rate = [(12% x 8.4M) + (8% x 1.8M)] ÷ (8.4M + 1.8M) =

(1,152,000 ÷ 10,200,000) = 11.29%

Capitalizable borrowing cost = (10% x 3.6M) + [(5.4M – 3.6M) x 11.29%] = 360,000 + 203,220 = 563,220

The interest capitalized is ₱563,220 (the lower of the avoidable interest of ₱563,220 and the actual interest cost incurred of ₱1,512,000
– see computation above).

3. Roger had the following loans in place at the beginning and end of 20x1:
Description 1 January 20x1 31 December 20x1
Bank loan, 6% p.a. 0 200,000
Bank loan, 8% p.a. 130,000 130,000
Debenture stock, 5.5% p.a. 50,000 50,000

a. The bank loan at 6% p.a. was taken in July 20x1 to finance the construction of a new
production hall (construction began on 1 March 20x1)
b. The bank loan at 8% p.a. and debenture stock were taken for no specific purpose and KLM
used them to finance general spending and the construction of a new machinery.
c. Roger used Php 60,000 for the construction of the machinery on 1 February 20x1 and
Php 25,000 on 1 September 20x1.

What borrowing cost should be capitalized?

The capitalization rate is computed as follows:

(130,000 x 8%) + (50,000 x 5.5%) ÷ (130,000 + 50,000) = (13,150 ÷ 180,000) = 7.31%

The “Bank loan, 6% p.a.” is ignored because it is a specific borrowing for another asset (i.e., “production hall” rather than “machinery”).

The weighted average expenditures is computed as follows:

(60,000 x 11/12) + (25,000 x 4/12) = 63,333

Borrowing cost = 7.31% x 63,333 = 4,630

The borrowing cost eligible for capitalization is 4,630 because it is lower than the actual borrowing cost of 13,150 (see computation
above).
4. On January 1, 2023, the Roger Co. began construction of a building to be used as its office headquarters.
The building was completed on June 30, 2024. Expenditures on the project, mainly payments to
subcontractors, were as follows:
January 3, 2023 600,000
March 31, 2023 300,000
September 30, 2023 600,000
Accumulated expenditures at December 31, 2023 (before interest capitalization) 1,500,000
January 31, 2024 600,000
April 30, 2024 300,000

On January 2, 2023, the company obtained Php 500,000 loan with an 8% interest rate for the building
construction. The loan was outstanding during the entire construction period. The company’s other interest-
bearing debt included two long-term notes of Php 2,000,000 and Php 4,000,000 with interest rates of 6%
and 12%, respectively. Both notes were outstanding during the entire construction period.

Compute for capitalizable borrowing interest for 2023 and 2024.

Solution for 2023:

Average accumulated expenditures (from general borrowings): Php 475,000

Weighted interest rate: 10%
Capitalizable borrowing cost: Php 87,500 (lower than actual)

Total expenditures for 2023, or at the beginning of 2024: Php 1,587,500

Solution for 2024:

Average accumulated expenditures (from general borrowings): Php 1,187,500 (See solution below)

January 1, 2024 Php 1,087,500* x 6/6 1,087,500

January 31, 2024 600,000 x 5/6 500,000
April 30, 2024 300,000 x 2/6 100,000
Php 1,687,500

*Php 1,587,500 less Php 500,000 specific borrowing

Average Accumulated Expenditure Annual Rate Fraction of Year

Php 1,687,500
Specific borrowing Php 500,000 8% 6/12 Php 20,000
Excess (General) Php 1,187,500 10% 6/12 Php 59,375
Php 79,375

Capitalizable borrowing cost for 2024: Php 79,375 (lower than actual)

MIAW