a) The avoidable interest on this project is $803,328.
b) The depreciation expense for the year ended December 31, 2021 is $466,777.60.
Explanation:
Note: This question is not complete but the complete one is presented before answering the question as follows:
Sandhill Furniture Company started construction of a combination office and warehouse building for its own use at an estimated cost of $12,000,000 on January 1, 2020. Sandhill expected to complete the building by December 31, 2020. Sandhill has the following debt obligations outstanding during the construction period:
Construction loan - 10% interest, payable semiannually, issued December 31, 2019; $4,800,000.
Short-term loan - 8% interest, payable monthly, and principle payable at maturity on May 30, 2021; $3,360,000.
Long-term loan - 9% interest, payable on January 1 of each year; principal payable on January 1, 2024; $2,400,000
a) Assume that Sandhill completed the office and warehouse building on December 31, 2020, as planned at a total cost of $12,480,000, and the weighted-average amount of accumulated expenditures was $8,640,000. Compute the avoidable interest on this project.
b) Compute depreciation expense for the year ended December 31, 2021. Harrisburg elected to depreciate the building on a straight-line basis and determined that the asset has a useful life of 30 years and a salvage value of 720,000.
The explanation to the answer is therefore presented as follows:
a) Assume that Sandhill completed the office and warehouse building on December 31, 2020, as planned at a total cost of $12,480,000, and the weighted-average amount of accumulated expenditures was $8,640,000. Compute the avoidable interest on this project.
This can be computed by following the following two steps.
Step 1: Computation of interest rate of other loan
Interest expense on short-term loan = $3,360,000 * 8% = $268,800
Interest expense on long-term loan = $2,400,000 * 9% = $216,000
Total interest expenses on other loans = Interest expense on short-term loan + Interest expense on long-term loan = $268,800 + $216,000 = $484,800
Total other loans = Short term loan + Long-term loan = $3,360,000 + $2,400,000 = $5,760,000
Interest rate of other loan = Total interest expenses on other loans / Total other loans = $484,800 / $5,760,000 = 0.0842, or 8.42%
Step 2: Computation of avoidable interest on this project
Since;
Weighted-average accumulated expenditures (WAAE) = $8,640,000.
Therefore we have;
Other loan based on WAAE = WAAE - Construction loan = $8,640,000 - $4,800,000 = $3,840,000
Interest on Construction loan = $4,800,000 * 10% = $480,000
Interest on other loan based on WAAE = Other loans based on WAAE * Interest rate of other loan = $3,840,000 * 8.42% = $323,328
Note that interest rate of other loan of 8.42% is calculated and taken from part a.
Avoidable loan = Interest on Construction loan + Interest on other loan based on WAAE = $480,000 + $323,328 = $803,328
Therefore, the avoidable interest on this project is $803,328
b) Compute depreciation expense for the year ended December 31, 2021. Harrisburg elected to depreciate the building on a straight-line basis and determined that the asset has a useful life of 30 years and a salvage value of 720,000.
Total cost of the building = Planned total cost + Avoidable interest expense = $12,480,000 + $803,328 = $13,283,328
Annual depreciation expenses = (Total cost of the building - Salvage value) / Useful life = ($13,283,328 - $720,000) / 30 = $466,777.60
Therefoe, the depreciation expense for the year ended December 31, 2021 is $466,777.60.
