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What is capitalized interest?

Author:
Harold Averkamp, CPA, MBA

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.

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About the Author

Harold Averkamp

For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.

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