Choice "A" is correct. The amount of interest which should be capitalized for the year ended December 31, Year 1, is $17,000. This amount is calculated as follows:Step 1: The weighted average accumulated expenditures must be calculated.
| Expenditure
amount
| Portion of
year outstanding
| Weighted average
accumulated expenditures
|
|---|
January 1: Purchase land | $120,000 | 12/12 | $120,000 |
September 1: Progress payment for contractor | 150,000 | 4/12 | 50,000 |
| | | $170,000 |
Step 2: Compute the capitalized interest by multiplying the appropriate interest rate times the weighted average accumulated expenditures. Because the weighted average accumulated expenditures are less than the amount borrowed, the interest rate to use is the rate on the borrowed funds. Capitalized interest is calculated as 10% × $170,000$17,000.Step 3: Compare the capitalized interest to the actual interest. The amount of interest capitalized cannot be greater than actual interest. Actual interest for the year would be $300,000 × 10%$30,000. The interest to capitalize is the lesser of actual interest or capitalized interest. Therefore, the amount of capitalized interest would be $17,000.Choice "c" is incorrect. This answer is calculated by multiplying 10% times the average of the two amounts spent: $150,000 + $120,000$270,000. $270,000 / 2$135,000. This is not the proper way to calculate weighted average accumulated expenditures.Choice "d" is incorrect. The amount of $15,000 would be 10% of the second progress payment. This is the wrong calculation to use for capitalized interest.Choice "b" is incorrect. The amount of $30,000 is the actual interest incurred by the company during Year 1. This is not the capitalized interest, based on the above explanations.
