6201 – Financial Accounting
Borrowing Costs Example
PART A
On 1 April 2011 ABC Ltd commenced the construction of factory premises for their
manufacturing operation. The factory was completed and ready for occupation on 30
September 2012. Payments for materials and services relating to the construction
activity were made as follows:
2 April 2011
30 June 2011
31 December 2011
31 May 2012
31 July 2012
31 August 2012
$
340,000
200,000
570,000
450,000
234,000
86,400
1,880,400
On 1 April 2011, ABC Ltd negotiated a loan for $1,600,000 for the duration of the
construction period. Interest at 12 percent per annum was payable on this loan.
ABC Limited has a financial year end of 31 March.
Required:
(a)
Calculate the interest to be capitalised for the year ending 31 March 2012,
assuming that the loan negotiated on 1 April 2011 was specifically for the
construction activity.
(b)
Prepare the journal entry at 31 March 2012 to record those costs of the
building that should be capitalised.
(c)
Calculate the interest to be capitalised for the year ended 31 March 2013.
(d)
Determine the total costs of the building premises at the end of
construction.
PART B
Using the information from Part A, assume that instead of borrowing funds for the
construction activity ABC Ltd had a $4,000,000 9 percent and $2,800,000 13 percent
long-term loan outstanding during the entire construction period.
Required:
Calculate the amount of interest that would be capitalised for the year ended 31
March 2012.
6201 – Financial Accounting
SOLUTION
(a)
First calculate the weighted-average expenditure to be used to determine
interest capitalisation:
2 April 2011
30 June 2011
31 December 2011
Accumulated
expenditure
$
340,000 x 12/12
200,000 x 9/12
570,000 x 3/12
1,110,000
Weightedaverage
expenditure
$
340,000
150,000
142,500
632,500
As the loan was negotiated specifically for the construction of the manufacturing
operation the interest to be capitalised is calculated as:
$632,500 x 12% = $75,900
(Note that this doesn’t affect the interest of $192,000 paid on the 12% $1.6m loan. It
simply means that $75,900 of this amount is capitalised and the balance of $116,100
expensed.)
(b)
Journal entry
J1.1
DR
CR
(c)
Calculate weighted average expenditure for 31 March 2013:
Manufacturing building
1,185,900
Cash
1,185,900
Capitalising construction costs of $1,110,000 and interest of $75,900
1 April 2012
31 May 2012
31 July 2012
31 August 2012
Accumulated
expenditure
$
*1,185,900
450,000
234,000
86,400
1,956,300
x
x
x
x
6/6
4/6
2/6
1/6
Weightedaverage
expenditure
$
1,185,900
300,000
78,000
14,400
1,578,300
* Amount of expenditure on project at balance date, meaning that during the current financial year
interest must be capitalised on this amount from 1 April 2012 to the end of the construction period.
6201 – Financial Accounting
The interest to be capitalised for the year ended 31 March 2013 amounted to:
$1,578,300 x 12% x 6/12 = $94,698
Journal entry
J2.1
DR
CR
Manufacturing building
865,098
Cash
865,098
Capitalising construction costs of $770,400 and interest of $94,698
(d)
Up to 31 March 2012, $1,185,900 is capitalised, with a further $865,098 for
the final six months, so overall the total cost of the building is $2,050,998.
PART B
As the funds were not borrowed to finance the construction activity, the average
interest rate on all debt must be calculated as follows:
Loan ($)
4,000,000
2,800,000
Interest rate (%)
9
13
Interest ($)
360,000
364,000
724,000
The weighted average of interest to total debt is 10.6 percent ($724,000 
$6,800,000).
The determinations will be the same as in Part A, but using the weighted average
interest rate.
So the interest capitalised for the first year (ended 31 March 2012) is:
$632,500 x 10.6% = $67,045