Capitalization of interest

Question 1

Computation

Answer 1

1. Average accumulated expenditure
2. Actual interest
3. Weighted average interest of other expenditures
4. Avoidable interest
5. Compare avoidable interest and actual interest
6. Take lower of the 2

Journal entry:

Asset
Interest expense

Question 2

Average accumulated expenditure formula

Answer 2

Beginning CIP

+ Ending CIP = total / 2

Question 3

Actual interest

Answer 3

computation depends on the problem
watch out carefully for dates
if the problem asks for a monthly interest expense to be capitalized or yearly

Question 4

Weighted interest rate of other borrowings - you need to compute this if there are 2 or more other borrowings aside from the main construction borrowing

Answer 4

Add interests on:

Borrowing #1
Borrowing #2
Total
Divide by
Total principal amounts of borrowings
= the Weighted average interest rate

Question 5

What assets qualify for interest capitalization?

Answer 5

Only those that require a period of time to be prepared

Assets constructed for sale as discrete projects
Assets constructed for own use whether by the
entity or by outsider requiring progress
payments

Interest on expenditures made to acquire land wherein a building is to be constructed - YES
interest - part of the cost of the building

Question 6

Interest paid for borrowings with the proceeds used to acquire a building. Can this be capitalized?

Answer 6

NO.

But if it is constructed over a period of time, YES.

Question 7

What should be capitalized?

Answer 7

Amount of interest which could have been avoided if the project not undertaken but not to exceed tha actual interest for the period.

Basic formula:

Ave. accumulated expenditures x interest rate x construction period

Question 8

What interest rate is used?

Answer 8

Rate on specific borrowings for the asset
or
Weighted average if specific is not available

Should be compounded

Question 9

Computation of compounded interest

Answer 9

Include capitalized interest from previous periods in the calculation of the average accumulated expenditures for the current period/subsequent periods

COMPUTED MONTHLY, QUARTERLY, SEMI ANNUALLY, YEARLY

Question 10

Interests income from borrowed funds which are temporarily invested

Answer 10

DO NOT OFFSET AGAINST THE INTEREST EXPENSE

Question 11

What doesn’t qualify for interest capitalization?

Answer 11

Routinely produced inventories
Assets ready for intended use when acquired
Idle equipment
Assets not being used nor readied for use
Land unless developed then interest is part
of the cost of the building

Question 12

When to capitalize?

Answer 12

All must be met:

1. expenditures for the asset have been made
2. activities intended to get asset ready are in
   progress
3. interest cost is being incurred

Question 13

Disclosure

Answer 13

In periods where no interest costs is capitalized - disclose the amt of interest cost incurred and charged to expense

Partial capitalization - total amount of interests costs incurred and the amount capitalized