Question

What is the justification for capitalizing interest related to a company’s long-term construction project (i.e., why does GAAP allow a calculation for interest capitalization)?

Answer 1

Justification for capitalizing interest related to a company’s long-term construction constrution

According to the accrual concept the expense should be recorded in the same period when the expense occured. but when the expenses are incurring for future benefits then. that expense should be capitalized

from the perspective of accrual accounting, capitalizing interest helps tie the costs of using a long-term asset to earnings generated by the asset in the same periods of use.

• Capitalized interest can only be booked if its impact on a company's financial statements is material. Otherwise, interest capitalization is not required, and it should be expense immediately.
• When booked, capitalized interest has no immediate effect on a company's income statement, and instead, it appears on the income statement in subsequent periods through depreciation expense.
• In accordance with the matching principle, capitalizing interest ties the costs of a long-term asset to the earnings generated by the same asset over its useful life.
• Capitalized interest is part of the historical cost of acquiring assets that will benefit a company over many years. Because many companies finance the construction of long-term assets with debt, Generally Accepted Accounting Principles (GAAP) allow firms to avoid expense interest on such debt and include it on their balance sheets as part of the historical cost of long-term assets.