302670 Flashcards
On January 1, Lyle Co. purchased a manufacturing facility. After remodeling was completed, the facility was ready for use on March 1. On April 1, production began. Interest costs were incurred as follows:
January 1 to March 1 March 1 to April 1 Building $10,000 $5,000 Remodeling 2,000 3,000 What amount of interest should Lyle capitalize during the current year?
$20,000
$12,000
$15,000
$10,000
$12,000
Lyle can capitalize the interest incurred on the project until the asset is ready for use. It does not matter when the actual production begins. Because the building could not be utilized (e.g., not ready for use) until the remodeling is complete, both the building’s interest and the remodeling’s interest are capitalizable until March 1 for a total of $12,000 ($10,000 + $2,000).
Capitalization of Interest
Capitalization of interest is to record the cost of interest (as well as other time-related costs, such as taxes and insurance) paid to finance a long-term construction project (whether self-constructed or acquired from others and whether for self-use or for resale) as an asset and defer its recognition as an expense to future periods. It is not to exceed the total interest incurred during that period.
FASB ASC 835-20
Conceptually, the amount of interest to be capitalized is the interest that could have been avoided if the expenditures for the asset had not been made. It requires determination of average accumulated expenditures during each interim capitalization period and the capitalization rate (usually the purchaser’s incremental borrowing rate or a weighted-average interest rate).
2243.01
If specified conditions are met, interest shall be capitalized for the following qualifying assets:
a. Assets that are constructed or otherwise produced for an enterprise’s own use (including assets constructed or produced for the enterprise by others for which deposits or progress payments have been made)
b. Assets intended for sale or lease that are constructed or otherwise produced as discrete projects (e.g., ships or real estate developments)
c. Investments (equity, loans, and advances) accounted for by the equity method while the investee has activities in progress necessary to commence its planned principal operations, provided that the investee’s activities include the use of the funds to acquire qualifying assets for its own operations
2243.02
Interest cost specifically shall not be capitalized for the following:
a. Assets that are in use or ready for their intended use in the earning activities of the entity
b. Assets that are not being used in the earning activities of the entity and that are not undergoing the activities necessary to get them ready for use
c. Assets that are not included in the consolidated balance sheet of the parent entity and consolidated subsidiaries
d. Investments accounted for by the equity method after the planned principal operations of the investee begin (i.e., after the investee no longer qualifies as a development stage enterprise)
e. Investments in regulated investees that are capitalizing both the cost of the debt and equity capital
f. Assets acquired with gifts and grants that are restricted by the donor or grantor to acquisition of those assets to the extent that funds are available from such gifts and grants. Interest earned from temporary investment of those funds that is similarly restricted shall be considered an addition to the gift or grant for this purpose.
g. Inventories that are routinely manufactured or otherwise produced in large quantities on a repetitive basis
2243.03
For qualifying assets, the interest cost incurred during the period of time required to carry out activities necessary to bring the asset to the condition and location necessary for its intended use is a part of the historical cost of acquiring the asset. The amount of interest to be capitalized during a given accounting period is determined by applying the appropriate capitalization rate to the average amount of accumulated expenditures for the asset during that period. Expenditures for this purpose are capitalized expenditures for the qualifying asset that have required the payment of cash, the transfer of other assets, or the incurring of a liability on which interest is recognized.
2243.04
In general, the capitalization rate shall be a weighted average of the rates applicable to borrowings (debt) outstanding during the accounting period for which the capitalizable interest is being calculated. However, if an enterprise associates a specific new borrowing with a qualifying asset, the enterprise may use the rate on that specific borrowing as the capitalization rate to be applied to that portion of the average accumulated expenditures for the asset that does not exceed the amount of the specific borrowing. If the average accumulated expenditures for the qualifying asset exceed the amount of that specific borrowing, the capitalization rate to be used on the excess is the weighted average of the rates applicable to other borrowings of the enterprise.
2243.05
The capitalization period normally begins when all of the following three conditions are present:
Expenditures for the asset have been made.
Activities that are necessary to get the asset ready for its intended use are in progress.
Interest cost is being incurred.
Interest capitalization shall continue as long as these conditions continue. The capitalization period ends when the qualifying asset is substantially complete and ready for its intended use.
