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Financial Accounting: capitalization of interest on PPE

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Capitalization of Interest

Wordcrafters Inc. is a book distributor that had been operating in its
original facility since 1982. The increase in certification programs and continuing education requirements
in several professions has contributed to an annual growth rate of 15% for Wordcrafters since 2002. Wordcraftersâ??
original facility became obsolete by early 2007 because of the increased sales volume and the fact
that Wordcrafters now carries tapes and disks in addition to books.
On June 1, 2007, Wordcrafters contracted with Favre Construction to have a new building constructed
for $4,000,000 on land owned by Wordcrafters. The payments made by Wordcrafters to Favre Construction
are shown in the schedule below.
Date Amount
July 30, 2007 $1,200,000
January 30, 2008 1,500,000
May 30, 2008 1,300,000
Total payments $4,000,000

Acquisition and Disposition of Property, Plant, and Equipment
Construction was completed and the building was ready for occupancy on May 27, 2008. Wordcrafters
had no new borrowings directly associated with the new building but had the following debt outstanding
at May 31, 2008, the end of its fiscal year.
141�2%, 5-year note payable of $2,000,000, dated April 1, 2004, with interest payable annually on April 1.
12%, 10-year bond issue of $3,000,000 sold at par on June 30, 2000, with interest payable annually on
June 30.
The new building qualifies for interest capitalization. The effect of capitalizing the interest on the new
building, compared with the effect of expensing the interest, is material.
(a) Compute the weighted average accumulated expenditures on Wordcraftersâ?? new building during
the capitalization period.
(b) Compute the avoidable interest on Wordcraftersâ?? new building.
(c) Some interest cost of Wordcrafters Inc. is capitalized for the year ended May 31, 2008.
(1) Identify the items relating to interest costs that must be disclosed in Wordcraftersâ?? financial
(2) Compute the amount of each of the items that must be disclosed.

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Solution Preview

Dates Amount Capitalized Period Weighted Average Accumulated Expenditures
July 30, 2007 1,200,000 6/12(.50) 600,000
January 30, 2008-1,500,000 4/12(.33) 495,000
May 30, 2008 1,300,000 0/12(0) 0
The table shows the computation of the weighted average accumulated expenditures. First take the dates and amounts of the payments of the loan. Then figure out the capitalized period by adding how many months in a year does it take between the first and second payment, the second and third payment and the last payment before the construction is finished. Multiply the amount paid times the ...

Solution Summary

Capitalization of interest on PPE is examined.