Definition of Capitalized Interest
Capitalized interest is the interest on debt that was used to finance a self-constructed, long-term asset.
The capitalized interest for the company's self-constructed asset involves the following:
- The cumulative amount of expenditures during the asset's construction
- The interest on the debt related to the asset's construction
- Adding the capitalized interest to the asset's cost instead of reporting it as interest expense of the current accounting period
- The capitalized interest will be depreciated over the asset's useful life as part of the asset's cost
Example of Capitalized Interest
Assume that a company is constructing an addition to its present manufacturing building. Its bank is lending the company $320,000 at an annual interest rate of 6% to cover 80% of the building addition's cost. The remaining 20% will be paid from the company's present cash balance. Also assume that the company's building materials, labor and overhead will amount to $400,000 during the three months of construction.
The capitalized interest is based on the 6% loan of $320,000 and the accumulated construction expenditures during the three-month construction period. The maximum amount of capitalized interest will be $320,000 X 6% X 3/12 = $4,800. If this ends up being the amount of capitalized interest, the asset's cost will be $404,800 which will be depreciated over the building's remaining useful life.