Capitalized vs Expensing Interest - Level II FRA (Continued)

Choices of interest rate that can be capitalized as part of the building’s cost include:
· Rate on existing borrowings.
· Rate on a borrowing that is specifically incurred for
constructing the asset. (if applicable)

Treatment of capitalized interest for constructing an asset for the company’s own use:
If interest expenditure is incurred while constructing an asset for the company’s own use, then the capitalized interest is recorded on balance sheet as part of the relevant long-lived asset and it is then expensed over time as part of depreciation expense.


Treatment of capitalized interest for constructing an asset to sell:
If interest expenditure is incurred while constructing an asset to sell then the capitalized interest is recorded on balance sheet as part of inventory and it is then expensed as part of the cost of sales when the asset is sold.


Adjusting Interest Coverage Ratio for Capitalization:
In order to have a true picture of company’s interest coverage ratio, both the capitalized and expensed portion of interest expenditure should be used in calculating interest coverage ratios. Income should also be adjusted to remove the effect of depreciation of previously capitalized interest.