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Arlington Company is constructing a building.Construction began on January 1 and was completed on December 31.Expenditures were $2,400,000 on March 1, $1,980,000 on June 1, and $3,000,000 on December 31.Arlington Company borrowed $1,200,000 on January 1 on a 5-year, 12% note to help finance construction of the building.In addition, the company had outstanding all year a 10%, 3-year, $2,400,000 note payable and an 11%, 4-year, $4,500,000 note payable.
-What amount of interest should be charged to expense?

Question

Quizplus · Accepted Answer

To calculate the interest expense, we need to calculate the weighted average interest rate for all the notes payable.

For the 12% note payable:

Interest expense = $1,200,000 * 12% = $144,000

For the 10%, 3-year, $2,400,000 note payable:

Interest expense = $2,400,000 * 10% = $240,000

For the 11%, 4-year, $4,500,000 note payable:

Interest expense = $4,500,000 * 11% = $495,000

To calculate the weighted average interest rate:

Weighted average interest rate = (Interest expense for 12% note payable + Interest expense for 10% note payable + Interest expense for 11% note payable) / (Total outstanding balance)

Total outstanding balance = $1,200,000 + $2,400,000 + $4,500,000 = $8,100,000

Weighted average interest rate = ($144,000 + $240,000 + $495,000) / $8,100,000 = 0.0948 or 9.48%

Total interest expense = (Weighted average interest rate) * (Average outstanding balance)

Average outstanding balance = ($2,400,000 + $2,190,000 + $5,190,000) / 3 = $3,593,333

Total interest expense = 9.48% * $3,593,333 = $340,792

Therefore, the amount of interest that should be charged to expense is $526,792 ($144,000 + $240,000 + $495,000 + $340,792).

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