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Capitalized Interest | Step to Calculate Capitalized Interest - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
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clicking the bell icon today we have a
topic with answers capitalised interest
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or what this topic is all about that's
what we are going to discuss here see
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there are few interest that is
capitalized and there are few which are
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not capitalized but it is actually
expensed on so what sort of interest is
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capitalized ok that's a very difficult
question and a very important question
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overall so first and the foremost thing
we'll learn is what is capitalized
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interest see capital interest is the
interest accrued during the construction
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of what we call as long term assets and
is included in the initial cost of
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assets on the balance sheet instead of
being charged off as the interest
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expense on the income statement for
example let's say if a 5% interest rate
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on let's talk about one lakh loan which
is borrowed to construct windmills it
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takes one year to complete the
construction so this implies that the
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cost of the wind wind will not only
improve the initial cost of asset but
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also the interest expense which has been
incurred here which is required to be
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paid off or for the load so the total
cost will be 100000 into 5%
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so we'll add this 5000 with 100000
that's gone be 105000
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and so here please you need to note one
thing that you know interest expense is
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not reported in the income statement
whereas the capitalized interest is
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added to the cost of the long-term asset
see under the cruel basis of accounting or
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the accrual basis of accounting it is
reported in the balance sheet as a total
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amount of fixed assets in the
organization using the construction loan
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to build its own corporate headquarters
is another example of such situation now
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the capital interest capitalisation
interest becomes a part of the long term
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asset and is depreciated it is
depreciated over the useful life now
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let's go to the next topic this was the
first one what exactly was the
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capitalized interest now the steps to
calculate capital
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interest what are the steps we'll start
with that step number one is find the
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capitalization period so the first step
is to understand the time be here until
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when the construction of the fixed
assets will take place and bye-bye when
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the assets will be ready for the use so
capitalization of the borrowing cost
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terminates when the asset has been
repaired its intended use and is
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substantially completed all the
activities are needed so the
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capitalization period will not be
extended by work minor modification
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modification so if the entity can use
some parts where you want construction
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continues on the other parts then should
discontinue the capitalization of the
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borrowing cost on the part that it
completes step number two calculate the
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weighted average accumulator expenditure
if the product of the expenditure for
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the construction of a fixed assets and
it's time weighted for the accounting year
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weighted average accumulated expenditure
is equal to the expenditure that you
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incur in to number of months in
capitalization divided by 12 step number
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3 the step 3 goes as you need to
determine the interest on the specific
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on the specific borrowing and from the
general funds you need to figure out so
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if the loan was specifically used for
the construction of the fixed asset okay
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then the actual borrowing cost incurred is
the borrowing cost to capitalize minus
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the borrowing cost less any kind of
investment income earned from that from
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the interim investment of those borrowing
now for general corporate needs the
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borrowing may be handled certainly
centrally and could be obtained by a
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variety of our debt instruments during
the period applicable to the asset in
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this case gain and interest rate from
the weighted average of the entity's
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borrowing costs
using the method number of allowable
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borrowing costs at the entities total
borrowing costs during the applicable
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period the step four is calculate the
avoidable calculate the avoidable
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interest so for calculating the
capitalized interest cost we need to
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calculate the avoidable interest well it
is calculated as w/e if that is weighted
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average of unit expenditures into
appropriate interest rate right so by
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that we receive avoidable interest right
this capitalize the avoidable interest
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expense you need to capitalize the same
finally step number five calculate the
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actual interest on loans
okay so actual interest on the overall
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loan is straightforward and you can
calculate directly by multiplying the
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corresponding interest rate so the debt
that has been raised in step six which
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is the final step
select the lowers the actual interest
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and avoidable interest as capitalisation
interest so capitalisation interest is
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going to be lower of the actual interest
and the voidable interest well this was
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our second discussion
the third discussion is going to be an
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example on this let's say there is a
construction company
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okay they started a construction of
building that is to be used for
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production and the construction the
building will end on let's say 31st of
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December and the building will be ready
to use the they were the following you
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know debt outstanding it was on the 1st
of January 2017 60,000 at $60,000 at 10%
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okay interest rate taken for the
specific purpose of construction of
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building and 75000 and 8%
interest rate that was basically
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general loan that was taken right so the
payments were made for the construction
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the building that was in the 1st feb
and that was made closely to
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50000 on the August
1st of August that was closely 75000
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so you need to calculate the capitalized
interest so I want you all do to solve
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this example by yourself by applying all
the steps over here the steps could be
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quite helpful and based on that just
make the calculations and come up with
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the answer the answer of the
capitalisation interest is gonna be
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$7367 dollars and try
and match your answer with the same let
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me give my final conclusion wordings on
this see to set the acquiring assets up
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to the intended use for a period of time
capitalized in interest is part of the
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historical cost the gaap allows the firm
to avoid expense interest on the debt as
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many companies finance the construction
of long term assets with either it's
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going to be debt and it includes on its
balance sheet as a component of the
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historical cost that is basically long
term assets so various production
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facilities ships real estates involves
long term assets for which the
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capitalization interest is allowed and
inventories that are manufactured over
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and over again in the large quantities
capitalization interest is not permitted
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for but that's it for this particular
topic right so that's it for this
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particular topic if you have learned and
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