South Park Company started construction of an office building for its own use at an estimated cost of
$5,000,000 on January 1, 2020. South Park expected to complete the building by December 31, 2020.
South Park has the following debt obligations outstanding during the construction period.
Construction loan12% interest, payable semiannually, issued December 31, 2019, principal
payable on January 1, 2022, $2,000,000
Short-term loan10% interest, payable monthly, issued January 1, 2020, principal payable at
maturity on May 30, 2021, $1,400,000
Long-term loan11% interest, payable on January 1 of each year; issued January 1, 2018,
principal payable on January 1, 2025, $1,000,000
Assume that South Park completed the office and warehouse building on December 31, 2020, as
planned, at a total cost of $5,200,000, and the weighted-average amount of accumulated
expenditures was $3,500,000.
Eric Cartman, the president of the company, has been shown the costs associated with this construction
project and capitalized on the balance sheet. He questions the line item capitalized interest and is
bothered by the fact that only the avoidable interest is included in the cost. He argues that, first, all
the interest is unavoidableno one lends money without expecting to be compensated for it. Second,
why cant the company use all the interest on all the loans when computing this avoidable interest?
Finally, why cant his company capitalize all the interest that was incurred over the period of
construction?
Instructions
You are the manager of accounting for the company. In a memo to Mr. Cartman, provide authoritative
support to explain that it is permissible to capitalize interest into the cost of asset and the type of assets
that qualify for interest capitalization. Also, explain what avoidable interest is and show how you
computed it (being especially careful to explain why you used the interest rates that you did), and why
the company cannot capitalize all its interest for the year. Support your analysis by referencing
accounting standards, and attach a schedule supporting any computations that you use. (Round the
weighted-average interest rate to two decimal places.)
Last Completed Projects
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