 Hello, and welcome to the session. This is Professor Farhad, and this session, we would look at an example that deals with interest capitalization. This topic is covered in intermediate accounting, as well as the CPA exam. As always, I would like to remind you to connect with me on LinkedIn, if you haven't done so. YouTube is where you would need to subscribe. I have 1,500 accounting, auditing, and tax lectures. Please subscribe, like my lectures, share them, put them in the playlist, let the world know about them. If they're benefiting you, it means they might benefit other people, so please go ahead and share the wealth. This is my Instagram account, this is my Facebook account, and I do have a website. On my website, you can access extra resources for accounting students and CPA candidates, including notes, slides, quizzes, 2,000 plus CPA questions, as well as other. Visit the website if you are interested. Also, I suggest if you're studying for the CPA exam, there's this company called studypal.com. It's an artificial intelligence driven study body platform that match you with another candidate. They have users in 85 countries and 2,500 cities, from LA to New York, so if you're interested, also you can check them out. So let's take a look at this example, because interest capitalization give students many problems, so let's go ahead and demystify by looking at an exercise. So let's take a look at this exercise. On December 31st, 2016, Maine borrowed $3 million at 12% to finance a construction of a new building. So since they borrowed this $3 million specifically for the new building, we're gonna call this specific borrowing. So this is the money that we're gonna be using first to cover the expenditure. In 2017, the company made the following expenditure related to this building. So they started the expenditure in March, 360,000, June 1.6 million, July 1.5 million, December 1.5 million, and the building was completed February 2018. Now, additional information, they have other debt. They have debt other than the $3 million that they borrowed specifically for this project. They have a bond, a 10-year bond, a $4 million 10-year bond. They have a note, a loan, a six-year, 10% note, 1.6 million, and March 1st expenditure included a land cost of 150, and they generated interest revenue of 49,000. So this is the information that we are giving. Now, if you don't have the slide, I'll copy this information down because I'm gonna move to Excel and work this problem on Excel. So I'll give you a minute if you wanna pause and copy the data down, okay? So the question is, determine the amount of interest to be capitalized in relation to the construction of the building and prepare the journal entry for the capitalization of interest and the recognition of interest expense. So as I said, I'm gonna go ahead and switch to an Excel sheet. So the first thing you have to compute when you are dealing with such a problem is something called the weighted average accumulated expenditure. And once you complete this, once you complete this computation, the rest is pretty simple. So how did we make the expenditure? The first expenditure, again, make sure you have written the data down. The first expenditure was made March 1st, and the amount was $360,000. Now you have to compute for how long it was outstanding, for how long it was outstanding. Well, if we spend the money March 1st, it means interest started to apply on this account. So it's simply put, this is when we spend the money. So in other words, once we spend the money, we assume the money is incurring interest. So it's gonna incur interest of 10-12 of the year. Why 10-12? All of March, all of April, May, June, July, August, September, October, November, and December, that's 10 months. So be careful whether it says the beginning of the month or at the end of the month. March 1st, you will count March. Now I always compute this percentage. It's, you don't see it in textbook. I just like to show you that this 360.833, it means the majority of the year was outstanding. I just like to do it for myself. You don't have to do it. Now the next thing we're gonna compute is the weighted average accumulated expenditure, which is the 360,000 times this ratio. This ratio is 10-12. I just put the ratio here, okay? Times 10-12. Now, which is 0.833 is equal to 10-12. So this is 0.833. If you look in the formula that I have here, it's 10 divided by 12, which is 10 month divided by 12 month. June 1st, we made another expenditure. We spent $600,000. And remember, this is June 1st, not the end of June. Therefore, this expenditure was outstanding for 712 of a year, which is a little bit than half a year, 0.58 little bit than half of a year. Now the weighted average accumulated expenditure will take the 600,000 divided by the fraction, which is 712, 350,000. On July 1st, a month later, we made another expenditure and we spent 1.5 million. That, well, if we made the expenditure July 1st, from July 1st till the end of the year, we have six month, which is 0.5, and the weighted average accumulated expenditure is 750, because we spent 1.5 million, but we didn't spend it the mid-year. Then on December 1st, we spent 1.5 million, and that's gonna accumulate interest for 112, or accumulate avoidable interest of 112, and the ratio is 0.08. So notice as you go toward the end of the year, the ratio goes down, just it's a check for me. Then the if I take 1.5 million multiplied by 0.0833, it's 125,000. So this is how much money that the company actually spent, 3,960, but the weighted average accumulated expenditure is 1,525, and this is the important number. This is the number that we are looking to compute, because from this number, what's gonna happen is we are going to, this is the number that's going to help us compute, that's gonna help us compute the avoidable interest. So simply put, in other words, if we did not undertake this project, we wouldn't have to spend this money, and if we didn't have to spend this money, we wouldn't have to, on average, spend this much money accruing interest. So 1,525. Now we need to compute, well, 1,525, but let me go back to the problem. I just wanna show you something real quick. For this project specifically, for this project specifically, we borrowed $3 million. We borrowed $3 million for this project specifically. What does that mean? That means, guess what? We don't have to compute, we don't have to compute the weighted average of other debt, the interest on other debt. Why? Because the money that we borrowed for this example happened to cover the, remember, we borrowed, let me make this a little smaller. Okay, let me make this. We borrowed $3 million, and we only going to have weighted average accumulated expenditure of 1,525. What does that mean? It means the avoidable interest is 1,525. Simply put, the avoidable interest is 1,500, not that avoidable interest, the weighted average accumulated expenditure is 1,525, which is less than the amount borrowed. So we don't need to compute the weighted average accumulated expenditure, the weighted average interest rate of other debt. In this problem, why? Because it's not needed. We don't need to do so. So if we take 1,525 multiplied by 20%, 12%, which is the interest on this debt, this is how much interest we incurred on this debt. Therefore we use this interest rate to multiply it by 1,525. We get to what's called avoidable interest. Now we get to what we call avoidable interest. Now what is the avoidable interest? Simply put, we could have avoided, we could have avoided 183,000 in interest, in theory, if we did not undertake this project. Why? Because we wouldn't have to spend this money. If we did not spend this money, in other words, we wouldn't have to borrow it. If we didn't have to borrow it, we would have saved on interest. So this is the avoidable interest. Simply put, in this problem again, we don't have to worry about computing the average interest of other debt. Now, this is the avoidable interest. Now we have to compute the other figure and the other figure is the actual interest. So what is the actual interest? Is how much interest we actually paid for this company? And what do you have to do? You have to go back to the problem. You have to go back to the problem itself. And we have this debt as well as this debt, in addition to the 3 million. So we have three, three liabilities. So let's compute the interest, the actual interest. Well, the first debt, let's take a look at it. The first one is 3 million and that's for the specific borrowing and we're gonna be paying 12% on that debt. So in the interest, 360, then we have another bond, 400,000 incurring 13%. And how do you compute the interest? The principal times the interest. It's for the full year and we have a third loan, 1.6 million incurring 10% interest and that's gonna be 160,000. Overall, the total interest is 1 million in the 1 million and 40,000. This is actual, this is what we call actual interest. This is how much actual interest the company paid. Now the question becomes, I mean, in general, when we have interest, interest is an expense. Interest is an expense, generally speaking. But in this problem, since we are building a building for our own use, the interest, some of the interest can be capitalized. How much can be capitalized? Well, how much can be capitalized depending on the lower of these two figures? We have to look at the avoidable interest and actual interest. Which one is the lower? The lower is 183,000. What does that mean? It means we actually paid 1,040,000 in interest. So simply put, cash paid, cash paid in interest, 1,040,000, this is how much we actually paid. Of this amount, 183,000 will be debited to building. This is the amount that is capitalized. It means it's treated as an asset. And the amount, the difference between 1,040,000 and 183,000, the difference is the amount that we are going to expense. We are going to expense 857,000. So we're gonna expense 857,000 of the 1,040,000 and capitalize 183,000. In the normal things, we would have debited the whole thing for interest expense. 1,040,000, that's the normal thing. But since this is a qualified asset, we can capitalize some of the interest because it's a construction. So the problem asks also about interest revenue. Simply put, interest revenue, we debit cash, credit revenue, interest revenue under USGAP. You don't have to worry about IFRS. How do we treat it under IFRS, okay? Okay, if you have any questions about this problem, please let me know. Also, I'm gonna be posting this problem in the slides and the Excel sheet on my website. So if you're interested, you can go to my website and if you're interested, you can proceed to downloading. Otherwise, study hard for your exam, study hard for your CPA exam and see you on the other side of success.