Self question 2

• Tumble co had the following loans in place at the beginning and end of 20x8.

1 Jan 20x8 31 DEC 20x8

$m $m

9% bank loan repayable 20y0

150 150

8% bank loan repayable 20Y1

90 90

7.5% debenture repayable 20y2

-- 200

Q2• The 7.5 per cent debenture was issued to fund

the construction of a qualifying asset( a piece of mining equipment), construction of which began on 1 Jul, 20X8.

• On 1 Jan 20X8 , tumble co began construction of a qualifying asset, a piece of machinery for a hydro-electric plant, using existing borrowings. Expenditure drawn down for the construction was : $25 million on 1 Jan 20x8, $30 million on 1 October 20X8.

• Calculate the borrowing costs that can be capitalized for the hydro-electric plant machine.

“Loan” not equal to “Expenditure drawn down”

Self question 2 answer

• Non construction loan

• Therefore, the average weight is 8.6%.

Debt Payment Interest Rate Interest Cost

Loan 150m 9% 13.5

90m 8% 7.2

Total 240(150+90)

8.6% 20.7(13.5+7.2)

Self question 2 answer

• Capitalize for 20X8

Expenditure Date

Amount Interest Capitalize

Fraction of outstanding year

Capital

1Jan 20x8 25m 8.625% 12/12 2.156

1Oct 20x8 30m 7.5% 2/12 0.375

3.5m

8.625% 3/12 0.647

2.803

In this example, it assumes that the 30m are also arising from non-construction loan.And, the question gives that the company began using existing borrowing on 1st January 2008.

Three months is counted from 1 October to 31 December as the construction on 1 October 2008.

Self q 2 Debt Amount Interest Rate Accumulated

Interest

Bank loan repayable 20Y0

150m 9% 13.5 m

Bank loan repayable 20Y1

90m 8% 7.2 m

Debenture repayable 20Y2

200m 7.5% 15m

Total Interest incurred

35.7 m

It can not calculate the total interest cost as the question did not indicate which month the “ 7.5% debenture repayable 20y2” was borrowed.

12/12 or other months??

Self question 3

• On 1 January 20X8 Allan Lee Co borrowed $20million to finance the production of two assets, both of which were expected to take a year to build. Production started at the beginning of 20x8. The loan facility was drawn down on 1 January 20X8, and was utilized as follows, with the remaining funds invested temporarily:

Self test question 3

The loan rate was 10 per cent and Allan Lee can invest surplus funds at 8 per cent.

RequiredIgnoring compound interest, calculate the borrowing

costs which may be capitalized for each of the assets and consequently the cost of each asset as at 31 December 20X8

Interest during period of construction Expenditure Date

Amount Interest Capitalize Rate

Fraction of outstanding

Capitalized

Jan 1, 20X8 10(4m +6m)

10% 12/12 1

Jul 1, 20X8 10 10% 5/12 0.42

1.42m

Less investment income

10(7+3)

8% 6/12 0.4

Borrowing cost 1.1

6/12 0.5

1.5

Total cost of asset =1.1+20m =21.1m

Self test question 3

Construction in progress 1.42Interest Expenses 8.58 Cash 10

20 10% 2

1.1

2

0.9

In this question, it gives that the 20 millions was borrowed on 1st January 2008.

Example: Commencement , suspension and cessation of capitalistion

Lam Co borrowed $ 10 million on 1 Jan 20x8 in anticipation of commencing work to build a new head office later in the year. The interest rate provided by Lam Co’s bank was 8 per cent per annum, and the loan had a term of 5 years. Construction began on 15 Feb and the property was occupied for use on 20 Dec 20X8 .

Question

• 1 Feb Expenditure on building materials began to be incurred

• 15 Feb Building materials began.• 6 May Building materials suspense due to

tropical storms, common to the region through May and June.

• 16 May Building work recommenced • 30 Nov Building work is completed and

approved to the regulatory authorities.

Question

• 1 Dec Decoration and finishing of the property to Lam Co’s specification commences

• 15 Dec Decoration and finishing work is completed.

• What journal entries are required to record the borrowing costs in the year ended 31 Dec ?

Answer • The average rate is 8 %.

• 8%*10.5/12

Dr Property under construction 630,000Dr Finance cost –I/S 170,000Cr Cash / interest accrual 800,000

63,000

9.5 months is counted from building cost begin (commences) (not just material began to be incurred. Activity need to be in progress.) to 30 November (not count the tropical storm / decoration and finishing for specification event.

15 Feb

Practice 10-5 cost of a self constructed asset (stice)

• The company constructed its own building. The cost of materials was $400 000. Labor cost incurred on the construction project was $600 000. Total overhead cost for the company for the year was $ 8 000 000; total labor cost (including the cost of construction ) was $ 4000000. Interest incurred to finance the construction cost was $ 140 000. Compute the total cost of the building.

Answer

• Cost of materials 400 000• Labour 600 000• Overhead cost 4 000 000 • Interest incurred 140 000 • Total cost of building 5140 000

1,200,000= 600,000/4,000,000*8,000,000

Question states that total overhead cost (construction + non-construction)=8mTotal labour cost (construction + non-construction)=4m.Construction labour cost =600,000

P10-9 Interest capitalization:specific interest method

• On Jan 1 2009, the Company began construction of a building to be used as its office headquarters. The building was completed on Sept 30,2010.

• Expenditure: January 3, 2009 $1,000,000» March 1, 2009 $600,000

• June 30, 2009 $800,000• October 1, 2009 $600,000 Jan 31, 2010 $270,000 April 30, 2010 $585,000 August 31, 2010 $900,000• On January 2, 2009, the company obtained $3m construction loan with a 10%

interest rate. The loan was outstanding all of 2009 and 2010. The company’s other interest bearing debt included two long term notes of $4,000,000 and $6,000,000 with interest rates of 6% and 8%, respectively. Both notes were outstanding during all of 2009 and 2010. The Company’s fiscal year end is 31st December.

Specificgeneral

P10-9 Interest capitalization:

• Date Cost Int. rate Fraction Cap. Int• 3 Jan $1,000,000 10% 12/12 $100,000• 1 Mar $600,000 10% 10/12 $50,000• 30 Jun $800,000 10% 6/12 $40,000• 1 Oct $600,000 10% 3/12 $15,000• Total capitalized interest for 2009 $205,000-FP

P10-92010yr:

• Date Cost Int.rate Fraction Cap.Int• 1 Jan 3,000,000 10% (9/9)*(9/12) 225,000• 1 Jan 205,000 7.2% (9/9) *(9/12) 11,070• 31 Jan 270,000 7.2% (8/9) *(9/12) $12,960• 30 Apr 585,000 7.2% (5/9) *(9/12) 17,550• 31 Aug 900,000 7.2% (1/9) *(9/12) 5,400• Total capitalized interest for 2010 $ 271,980

PRINCIPLE RATE4,000,000 6% 240,0006,000,000 8% 480,00010,000,000 720,000Average rate : 720,000/ 10,000,000 =7.2%

• 2009:Dr. Construction in Progress 205,000• Interest expense 815,000• Cr. Cash 1,020,000• 2010: Dr. Construction in Progress 271,980• Interest expense 748,020• Cr. Cash 1,020,000 (x1,034,760)(to Bank)

• 1,020,000 +205,000*7.2%=14,760 +1,020,000• =1,034,760• Compound= Last year interest has not been paid.• This year amount interest include L.Y. unpaid interest