When is interest expensed or capitalized?
Disclosure should be made of the interest capitalized and expensed. Interest incurred on borrowed funds is expensed. However, interest on borrowed money is capitalized to the asset account and then amortized in the following instances:
o Self-constructed assets for the entity's own use. To justify interest capitalization, a time period must exist for assets to be prepared for use.
o Assets purchased for the company's own use by arrangements mandating a down payment and/or progress payments.
o Assets for sale or lease constructed as discrete, individual projects (e.g., real estate development).
Interest is not capitalized for:
o Assets produced in large volume or on a repetitive basis
o Assets in use or ready for use
o Assets not in use and not being prepared for use
What interest rate is used?
Interest capitalized is based on the average accumulated expenditures for that asset. The interest rate used is either:
o Weighted-average interest rate of corporate debt
o Interest rate on the specific borrowing
When does the capitalization period begin and end?
The interest capitalization period commences when the following exist:
o Expenditures have been incurred.
o Work is proceeding to make the asset ready for intended use. These activities are not limited to actual construction but may also include administrative and technical functions prior to the time of construction. Included are costs of unforeseen events taking place during construction. EXAMPLES: Labor problems and litigation.
o Interest is being incurred.
The capitalization period ceases when the asset is materially complete and usable. When an asset has individual parts (e.g., condominium units), the capitalization period of interest costs applicable to one of the separate units ends when the specific unit is materially finished and usable. Capitalization of interest is not continued when construction ends, except for brief or unexpected delays. When the total asset must be finished to be useful, interest capitalization continues until the total asset is materially complete. EXAMPLE: A manufacturing plant where sequential production activities must take place.
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