Interest Capitalization

Question

Counting Crows make the following construction-related expenditures: 450,000 on January 1st, 2021 300,000 on October 1st, 2021 600,000 on December 1st, 2021 200,000 on March 1, 2022, and construction ends on March 31, 2022. They have a 300,000 construction loan at 6 percent. In addition, they have a 1,000,000 loan at 4 percent and a 3,000,000 at 5 percent. How much depreciation expense do they recognize in 2022 if the company uses straight-line depreciation, begins as soon as construction is finished, and the building has a 30-year useful life and a residual value of 200,000?

Answer 1

A. Borrowing cost included in value of building

1. 300000*6/100*15/12 = 22500

2. capitalization rate = (1000000*4/100)+(3000000*5/100)/ 1000000+3000000 = 4.75%

(150000*4.75/100*15/12)+(600000*4.75/100*4/12)+(300000*4.75/100*6/12)+(200000*4.75/100*1/12)= 26325

3.Total value of building = 450000+600000+300000+200000+22500+26325

= 1598825

4.Depriciation = (1598825-200000)/30 = 46630.

Answer 2

First you need to find the interest on loan up to March 2022. This is the date when the asset becomes usable and all interest paid before that should be capitalized [added to the cost of the asset]. The construction cost is 450 + 300+600+200. Calculate interest on the construction loan of 300k for the whole period from 1 Jan 2021 to 31 Mar 2022. The other two loans are loans for some other purpose.

Add the interest to the cost of the asset. Deduct salvage value and divide by 30 which is the useful life.

That would be the annual depreciation. For the year 2022 as the building becomes usable by 31 Mar 2022 calculate proportional depreciation from the annual one for Apr to Dec ie 9 months.