12-1 Capitalization of Interest Chapter 12 Illustrated Solution: Problem 12-45

12-2 Problem Background Oceanwide Enterprises, Inc. If a company self-constructs long-lived assets, they may be entitled to capitalize some interest costs as part of the overall cost of the asset. One of the restrictions is that a company may never capitalize more interest costs than they actually incur (in any fiscal year).

12-3 Part 1: Maximum Interest Capitalized in 2002 Oceanwide Enterprises, Inc interest accrued: 12% 5-year note ($2,000,000 x 12%)…………….$ 240,000 10% 10-year bonds ($8,000,000 x 10%)………….800,000

12-4 Part 1: Maximum Interest Capitalized in 2002 Oceanwide Enterprises, Inc interest accrued: 12% 5-year note ($2,000,000 x 12%)…………….$ 240,000 10% 10-year bonds ($8,000,000 x 10%)………….800,000 13% 3-year loan ($2,000,000 x 13%)…………….. 260,000 Total interest accrued—2002……………….$1,300,000

12-5 Oceanwide Enterprises, Inc. Funds borrowed as general liabilities cannot be identified with any specific construction project. It is also common that the interest rate varies between different loans and borrowings. Therefore, a weighted-average interest rate must be computed for all general liabilities.

12-6 Part 2: Weighted-Average Interest Rate Oceanwide Enterprises, Inc. Weighted-average interest rate for the general liabilities for 2002: Loan AmountRateInterest Expense $2,000,000x12%=$ 240,000 8,000,000x10%=800,000 $10,000,000$1,040,000

12-7 Part 2: Weighted-Average Interest Rate Oceanwide Enterprises, Inc. Weighted-average interest rate for the general liabilities for 2002: Loan AmountRateInterest Expense $2,000,000x12%=$ 240,000 8,000,000x10%=800,000 $10,000,000$1,040,000 Weighted-average interest rate: ($1,040,000  $10,000,000) = 10.4%

12-8 Part 2: Weighted-Average Interest Rate Oceanwide Enterprises, Inc. Weighted-average interest rate for the general liabilities for 2002: Loan AmountRateInterest Expense $2,000,000x12%=$ 240,000 8,000,000x10%=800,000 $10,000,000$1,040,000 Weighted-average interest rate: ($1,040,000  $10,000,000) = 10.4% This rate will be associated with any expenditures made on construction projects where the expenditures exceed any borrowings that are specific to a project.

12-9 Part 3: Interest to be Capitalized in 2002 Oceanwide Enterprises, Inc. Ship No. 340 was completed in October No construction costs were incurred on this project in 2002; therefore, there is no capitalized interest in 2002 for Ship No. 340.

12-10 Part 3: Interest to be Capitalized in 2002 ExpendituresAmount Interest Capitalization Rate (%) Fraction of the Year Outstanding Capitalized Interest Ship #341: As of Jan. 1, 2002$1,150, /12$ 59,800

12-11 Part 3: Interest to be Capitalized in 2002 ExpendituresAmount Interest Capitalization Rate (%) Fraction of the Year Outstanding Capitalized Interest Ship #341: As of Jan. 1, 2002 April 1, 2002 $1,150,000 1,200, /12 3/12 $ 59,800 31,200

12-12 Part 3: Interest to be Capitalized in 2002 ExpendituresAmount Interest Capitalization Rate (%) Fraction of the Year Outstanding Capitalized Interest Ship #341: As of Jan. 1, 2002 April 1, 2002 $1,150,000 1,200, /12 3/12 $ 59,800 31,200 Ship #342: As of Jan. 1, 20021,200, /1293,600

12-13 Part 3: Interest to be Capitalized in 2002 ExpendituresAmount Interest Capitalization Rate (%) Fraction of the Year Outstanding Capitalized Interest Ship #341: As of Jan. 1, 2002 April 1, 2002 $1,150,000 1,200, /12 3/12 $ 59,800 31,200 Ship #342: As of Jan. 1, 2002 May 1, ,200,000 1,600, /12 5/12 93,600 69,333

12-14 Part 3: Interest to be Capitalized in 2002 ExpendituresAmount Interest Capitalization Rate (%) Fraction of the Year Outstanding Capitalized Interest Ship #341: As of Jan. 1, 2002 April 1, 2002 $1,150,000 1,200, /12 3/12 $ 59,800 31,200 Ship #342: As of Jan. 1, 2002 May 1, ,200,000 1,600, /12 5/12 93,600 69,333 Ship #343: As of Jan. 1, , /1297,500

12-15 Part 3: Interest to be Capitalized in 2002 ExpendituresAmount Interest Capitalization Rate (%) Fraction of the Year Outstanding Capitalized Interest Ship #341: As of Jan. 1, 2002 April 1, 2002 $1,150,000 1,200, /12 3/12 $ 59,800 31,200 Ship #342: As of Jan. 1, 2002 May 1, ,200,000 1,600, /12 5/12 93,600 69,333 Ship #343: As of Jan. 1, 2002 July 1, ,000 1,250, /12 6/12 97,500 81,250

12-16 Part 3: Interest to be Capitalized in 2002 ExpendituresAmount Interest Capitalization Rate (%) Fraction of the Year Outstanding Capitalized Interest Ship #341: As of Jan. 1, 2002 April 1, 2002 $1,150,000 1,200, /12 3/12 $ 59,800 31,200 Ship #342: As of Jan. 1, 2002 May 1, ,200,000 1,600, /12 5/12 93,600 69,333 Ship #343: As of Jan. 1, 2002 July 1, ,000 1,250, , /12 6/12 97,500 81,250 49,400

12-17 Part 3: Interest to be Capitalized in 2002 ExpendituresAmount Interest Capitalization Rate (%) Fraction of the Year Outstanding Capitalized Interest Ship #341: As of Jan. 1, 2002 April 1, 2002 $1,150,000 1,200, /12 3/12 $ 59,800 31,200 Ship #342: As of Jan. 1, 2002 May 1, ,200,000 1,600, /12 5/12 93,600 69,333 Ship #343: As of Jan. 1, 2002 July 1, ,000 1,250, , /12 6/12 97,500 81,250 49,400 Ship #344: Sept. 1, , /1228,080

12-18 Part 3: Interest to be Capitalized in 2002 ExpendituresAmount Interest Capitalization Rate (%) Fraction of the Year Outstanding Capitalized Interest Ship #341: As of Jan. 1, 2002 April 1, 2002 $1,150,000 1,200, /12 3/12 $ 59,800 31,200 Ship #342: As of Jan. 1, 2002 May 1, ,200,000 1,600, /12 5/12 93,600 69,333 Ship #343: As of Jan. 1, 2002 July 1, ,000 1,250, , /12 6/12 97,500 81,250 49,400 Ship #344: Sept. 1, , /1228,080 Ship #345: Nov. 1, , /126,240

12-19 Part 3: Interest to be Capitalized in 2002 ExpendituresAmount Interest Capitalization Rate (%) Fraction of the Year Outstanding Capitalized Interest Ship #341: As of Jan. 1, 2002 April 1, 2002 $1,150,000 1,200, /12 3/12 $ 59,800 31,200 Ship #342: As of Jan. 1, 2002 May 1, ,200,000 1,600, /12 5/12 93,600 69,333 Ship #343: As of Jan. 1, 2002 July 1, ,000 1,250, , /12 6/12 97,500 81,250 49,400 Ship #344: Sept. 1, , /1228,080 Ship #345: Nov. 1, , /126,240 Total capitalized interest for 2002$516,403

12-20 End of Problem