Capitalized Interest

What Is Capitalized Interest?

Capitalized interest is the cost of borrowing to get or develop a long-term asset. Dissimilar to an interest expense incurred for some other purpose, capitalized interest isn't expensed immediately on the income statement of a company's financial statements. All things being equal, firms capitalize it, meaning the interest paid expands the cost basis of the connected long-term asset on the balance sheet. Capitalized interest appears in portions on a company's income statement through periodic depreciation expense recorded on the associated long-term asset over its helpful life.

Figuring out Capitalized Interest

Capitalized interest is part of the historical cost of securing assets that will benefit a company over numerous years. Since many companies finance the construction of long-term assets with debt, Generally Accepted Accounting Principles (GAAP) permit firms to try not to expense interest on such debt and remember it for their balance sheets as part of the historical cost of long-term assets.

Normal instances of long-term assets for which underwriting interest is permitted incorporate different production facilities, real estate, and boats. Promoting interest isn't permitted for inventories that are manufactured tediously in large quantities. U.S. tax laws likewise permit the capitalization of interest, which gives a tax deduction in later years through a periodic depreciation expense.

According to the viewpoint of accrual accounting, underwriting interest helps tie the costs of utilizing a long-term asset to earnings generated by the asset in similar periods of purpose. Capitalized interest must be booked on the off chance that its impact on a company's financial statements is material. In any case, interest capitalization isn't required, and it ought to be expensed immediately. At the point when booked, capitalized interest meaningfully affects a company's income statement, and on second thought, it shows up on the income statement in subsequent periods through depreciation expense.

Significant

As per the matching principle, underwriting interest ties the costs of a long-term asset to the earnings generated by similar asset over its valuable life.

Illustration of Capitalized Interest

Consider a company that forms a small production facility worth $5 million with a helpful life of 20 years. It gets the amount to finance this project at an interest rate of 10%. The project will require a year to complete to put the building to its planned use, and the company is permitted to capitalize its annual interest expense on this project, which amounts to $500,000.

The company capitalizes interest by recording a debit entry of $500,000 to a fixed asset account and an offsetting credit entry to cash. Toward the finish of construction, the company's production facility has a book value of $5.5 million, comprising of $5 million in construction costs and $500,000 in capitalized interest.

In the next year, when the production facility is utilized, the company books a straight-line depreciation expense of $275,000 ($5.5 million of the facility's book value partitioned by 20 years of helpful life) of which $25,000 ($500,000 of capitalized interest separated by 20 years) is attributable to the capitalized interest.

Features

• Since many companies finance long-term assets with debt, companies are permitted to expense the assets over the long term.
• By promoting the interest expense, companies are able to generate revenue from the asset to pay for it over the long haul.
• Capitalized interest is the cost of borrowing to get a long-term asset.
• Dissimilar to run of the mill interest expenses, capitalized interest isn't expensed immediately on a company's income statement.