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The question is as follows:
X has borrowed 2.4 million to finance the building of a factory. Construction is expected to take two years. The loan was drawn down and incurred on 1 January 2009 and work began on 1 March 2009. $1 million of the loan was not utilised until 1 July 2009 so X was able to invest until needed.
X is paying 8% on the loan and can invest surplus funds at 6%.
Calculate the borrowing cost to be capitalised for the year ended 31 December 2009 in respect of this project.
BPP’s answer: $130,000 …but how? when i worked it out, i got $148,000 (which isn’t any of the options in the MCQ).
Their working:
Borrowing costs March – December (2.4m x 8% x 10/12)
Less investment income (1m x 6% x 6/12)But surely it would be reasonable to assume that X would invest the money from the moment the loan is drawn down? And from which point the loan will incur interest from day one (rather than from March as the answer suggests). And why have they assumed that the 1m is invested for 6 months??
Some clarification would be much appreciated!
Borrowing costs are not capitalisable until work commences. The interest incurred during the 2 months before work commenced must therefore be expensed
I’m surprised by their interest received calculation! I would have thought that it should be for 1 March through 30 June ie 4 months.
Impossible in an exam question to give precise dates of every amount spend – it’s not like in real life.
When an amount is drawn down and some is invested, the presumption is that the amount spent is all spent on the day it is drawn down. Unrealistic? Yes, of course!
I think the answer should be $160,000 less $1m * 6% * 4/12 = $200,000
A total of $140,000!
Thanks for the clarification. It does make sense now to know you can only capitalise the interest once construction begins.
From this, it is fair to assume that only the investment income AFTER construction began is considered in the calculation of the amount to capitalise?
And yes it is rather strange they used 6 months. Probably a typo.
That’s the only thing I can put it down to. A borrowing cost question was asked maybe 2 exams ago and specifically the examiner said that the interest income could only be taken to reduce the capitalized cost for the same period that the interest paid was capitalised
Ok?
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