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