Explain how Weighted Average Accumulated Expenditures (WAAE) are calculated and how WAAE is used to calculate capitalized interest.
The Correct Answer and Explanation is:
Weighted Average Accumulated Expenditures (WAAE) is a method used in accounting to determine the amount of interest that should be capitalized on a construction project. It reflects the average amount of money spent on construction over time, weighted by how long each expenditure has been outstanding.
Calculation of WAAE:
- Determine Expenditures: Identify the amounts spent on the project during different periods. For example, if a company made multiple purchases or incurred expenditures in different months, each amount needs to be tracked separately.
- Assign Time Periods: For each expenditure, calculate the length of time from the date it was incurred until the end of the accounting period (typically the end of the project or the financial year).
- Weight the Expenditures: Multiply each expenditure by the fraction of the year it was outstanding. For example, an expenditure incurred at the beginning of the period would be weighted more heavily than one incurred towards the end of the period.
- Sum the Weighted Expenditures: Add up the weighted expenditures to get the WAAE. The result is the average accumulated expenditure, adjusted for the time each amount was outstanding.
The formula for WAAE is:WAAE=∑(Expenditure×Months Outstanding12)WAAE = \sum (\text{Expenditure} \times \frac{\text{Months Outstanding}}{12})WAAE=∑(Expenditure×12Months Outstanding)
Where:
- Expenditure is the amount spent in each period.
- Months Outstanding is the number of months the expenditure was outstanding during the year.
Use of WAAE to Calculate Capitalized Interest:
Once the WAAE is calculated, it is used to determine the amount of interest to be capitalized. The formula for capitalized interest is:Capitalized Interest=WAAE×Interest Rate\text{Capitalized Interest} = \text{WAAE} \times \text{Interest Rate}Capitalized Interest=WAAE×Interest Rate
Where:
- WAAE is the weighted average accumulated expenditures.
- Interest Rate is the effective interest rate on the borrowings used to finance the project.
Capitalized interest represents the interest cost incurred during the construction period that should be included as part of the cost of the asset. This amount is added to the value of the asset on the balance sheet rather than being expensed immediately, reflecting the fact that the interest relates to the development of a long-term asset.
