Generally Accepted Accounting Principles
in the United States

U.S. GAAP Codification Accounting Topics



Capitalization of Interest Cost

Principles of Accounting,  U.S. GAAP Financial Reporting Guide
Accounting by Topic, Accounting Terms Dictionary


Summary of SFAS No. 34

 FASB Statement of Financial Accounting Standards (SFAS) No. 34
          Capitalization of Interest Cost , October 1979
 
  Cost of an asset acquired
          --> includes all costs necessary
                   (to make the asset ready for intended use)

 Interest cost incurred
          --> during the period
                    (to make the asset ready for intended use)
          --> is a part of acquisition cost of the asset.

 Assets qualified for interest capitalization
      Assets constructed
          a. for the entity's own use
          b. for sale or lease "as discrete projects"

          --> Examples:  Ships, Real estate developments  

 Assets not qualified for interest capitalization
          a.  Inventories
          b.  Assets that are
                  --> in use
                  --> ready for intended use
                  --> not used in the earning activities

 Amount to be capitalized

          a.  In general,

            --> Average amount of accumulated expenditures
                       (for the period)
                  x interest rate (capitalization rate)

          b.  Specific borrowing for certain assets

            --> Average accumulated expenditures
                        (up to the amount of specific borrowing)
                  x interest rate of specific borrowing 

          c.  Amount exceeding specific borrowing

            --> Average accumulated expenditures
                        (over the amount of specific borrowing)
                  x weighted average interest rate of other borrowings
 

An Example of Interest Capitalization
 
  Example 1

  Company A began a construction on January 1, 2011.
      a.  Company A borrowed $2 million on January 1, 2011 to finance this construction project.
      b.  Annual interest rate for $2 million is 8%.
      c.  Other borrowings of Company A:
              $15 million at 10% annual interest rate
              $25 million at 12% annual interest rate

      d.  Expenditures that incurred evenly during the year:
              2011:  $6,000,000
              2012:  $12,000,000
              2013:  $3,000,000

      e.  The plant became ready for use on April 30, 2013.
      f.   The plant began actual production on July 1, 2013.

 Step 1:  Weighted average interest rate
  
     Interest rate for specific borrowing:  8%
     Weighted average interest rate for other borrowings:
 
  Amount Interest Rate Interest Cost
  $15,000,000 10% $1,500,000
  $25,000,000 12% $3,000,000
Total $40,000,000   $4,500,000

     Weighted average interest rate = $4,500,000 / $40,000,000 = 11.25%    

 Step 2:  Average cumulative expenditures
 
    2011 2012 2013
A Beginning accumulated expenditures   $3,272,250 $10,250,656
B Expenditures incurred during the year $6,000,000 $12,000,000 $3,000,000
C=A+B Ending accumulated expenditures $6,000,000 $15,272,500 $13,250,656
D=(A+C)/2 Average accumulated expenditures $3,000,000 $9,272,500 $11,750,656
E Interest cost to be capitalized $272,250 $978,156 $418,983
F=C+E Accumulated expenditures after interest capitalization $3,272,250 $10,250,656 $12,169,639

 Interest cost to be capitalized
 
  Borrowing Interest rate Interest cost No. of Months Interest to be capitalized
  $2,000,000 8% $160,000    
  $1,000,000 11.25% $112,500    
2011 $3,000,000   $272,500 12 $272,500

  Borrowing Interest rate Interest cost No. of Months Interest to be capitalized
  $2,000,000 8% $160,000    
  $7,272,000 11.25% $818,156    
2012 $9,272,000   $978,156 12 $978,156

  Borrowing Interest rate Interest cost No. of Months Interest to be capitalized
  $2,000,000 8% $160,000    
  $9,750,000 11.25% $1,096,949    
2013 $11,750,656   $1,256,949 4 $418,983

   
Interest Capitalization Example 1 in pdf 
Interest Capitalization Example 2 in pdf 
Interest Capitalization Example 3 in pdf 



U.S. GAAP Codification
 
Accounting Topics
Inventory Valuation Methods
Depreciation Methods
Revenue Recognition Principle
Accrual Basis vs. Cash Basis Accounting
Basics of Journal Entries
Ratios for Financial Statement Analysis
Overview of Financial Statements


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