David presents a precise definition of interest capitalization. The description articulates how capitalized interest is recorded in the balance sheet. It is the cost of funds that a business uses to finance its long-term assets. David explains that capitalized interest results in an increase in the value of fixed assets. Besides the clear definition of interest capitalization, David lists conditions that businesses should fulfill to practice interest capitalization.
David notes that interest capitalization period must exclusively be from the time when the project commences up to when the fixed asset is wholly complete and ready for use. The period may also end at the time when there is no more interest accrual. I find this concept of capitalized period important in consideration of capitalized interest. Second, David highlights the concept of average accumulated expenditures. The capitalized interest amount should be limited to expenses that were avoidable if the investment in the fixed asset was not made. This consideration is important in informing the calculation of capitalized interest; only the actual expenditures in the fixed asset investment should be subjected to the interest.
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David enumerates two distinct methods applicable in determining the interest rates. In the first circumstance, the interest rate is an equivalent of interest charged on the funds borrowed exclusively to finance the fixed asset’s project. Alternatively, it can be calculated as a weighted-average interest on all other debts that the business has. David’s explanation of the three-step process is accurate and comprehensive in determining the capitalized interest rates.
