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Hello sir, I am reposting this question as you closed the chapter without hearing back from me.
I think you should give reasons why full amounts are used while other questions require that part amounts be used proportionately.
Had there been no Investment of idle funds, we then would have had to allocate funds proportionately right?
On 1 January 20X6 Stremans Co borrowed $1.5m to finance the production of two assets, both of which
were expected to take a year to build. Work started during 20X6. The loan facility was drawn down and
incurred on 1 January 20X6, and was utilised as follows, with the remaining funds invested temporarily.
Asset A Asset B
$’000 $’000
1 January 20X6 250 500
1 July 20X6 250 500
The loan rate was 9% and Stremans Co can invest surplus funds at 7%.
Required
Ignoring compound interest, calculate the borrowing costs which may be capitalised for each of the assets
and consequently the cost of each asset as at 31 December 20X6.
Asset A.500 x 9%=45 for asset A but
I expected it to be
250 x 9% + 250 x 9% x 6/12 =33.75Frederico, you ask “Had there been no Investment of idle funds, we then would have had to allocate funds proportionately right?”
and here’s a re-post of part of my previous response:
“So borrowing costs capitalised will be:
9% x $1.5 million x 12/12 = $135,000
less
7% x $750,000 x 6/12 = $26,250
giving an aggregate of $108,750 and that’s split $36,250 for asset A and $72,500 for asset B”
This figure above of $36,250 for asset A is made up of:
500/1,500 x $135,000 total capitalised borrowing cost = $45,000
less
500/1,500 x $26,250 interest earned on temporary investment = $8,750
giving us an aggregate figure of $45,000 – $8,750 = $36,250
So, you see, I HAVE apportioned both the borrowing costs and the interest earned by taking 500/1,500 of the borrowing costs figure and 500/1,500 of the interest earned figure
Is that better?
Thanks sir but I still have a question.
In a sole example on borrowing costs in lecture notes, the solution in a video lecture uses proportionate amounts, unlike in this question.
Could you please make it clear to me why a different approach was used ? One which if used here, would have given a different answer.
What’s the name of the question? I thought the only example was Edigijus and there’s no concept of apportionment in that question!
The solution of that question actually accounts for only relevant periods unless I am mistaken .
Anyway, help me with the terms
-Borrowed
-Incurred
-PaidHow do we treat them?
“The solution of that question actually accounts for only relevant periods”
Thank Heavens for that! So it looks like I did it correctly then!
When you borrow money to spend on a project, you borrow money! And the bank will start charging interest on that borrowing from the very first day that you borrow the money
The bank is totally uninterested in when you start the project nor even whether you start the project. You will start paying interest as soon as the bank puts that borrowing at your disposal
But for accounting terms, the interest payable on those borrowings is to be capitalised but only during relevant periods – ie those periods where the project is actually started and being worked on but not those periods where work is suspended because of, for example, snow
The capitalisation of the interest ceases when the project is substantially complete – but who is going to decide “substantially”?
When you have those borrowings in your account under your control, you then start to spend that money on the project and that means that you are incurring costs on the project.
And if you are incurring costs then the suppliers of the materials and the workforce supplying their labour will expect to be paid for those services and that labour
As for your question “How do we treat them?” surely that’s covered in the lecture and in the worked example of Edigijus
Better?
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