Question

When calculating avoidable interest, what is considered material vs immaterial? GAAP requires interest capitalization for a qualifying asset only if its effect is material. But my textbook doesn't explain what is considered material?

I have always capitalized fixed assets over $2500. anything less is expensed. But I don't know how to apply this concept to capitalized interest.

Thank you for your help.

Answer 1

Answer:

A) The concept of material or immaterial is related to the importance of certain information which are required to be reflected in the financial statement in order to represent the true picture of the financial health of the organisation. Now the information may be material for a small size company, however, the same may not be material for a larger size come which may be treated as immaterial by the larger size company. As explained, omission of such information in the financial statement may have a serious effect for a mall size company and the same will be treated as material information but omission of such information in the financial statement may not have any such effect for a large size company and the same will be treated as immaterial information.

B) Normally a company takes loan, whose extent is depended on the amount of equity it has. Now the money borrowed by a company attracts an interest payment. In this context please note the following:

1. Loan is taken for capital expenditure for building of assets for the purpose of expansion of plant capacity, for production of new product etc.
2. Loan is taken for construction of real estate or such asset which will be meant for selling.
3. When the interest accrued due to CAPEX (Capital Expenditure), it is added with assets and also shown in the balance sheet thereby increases the asset over liability. Now in this case, the concept of material comes into picture.
4. When the interest is treated as an expenditure in the case where the asset is constructed for selling it will be shown in the income statement and it will not be added with the asset since asset built is meant for sale. Hence, in this case concept of immateriality comes into picture.
5. From the above it is clear when interest capitalization will take place i.e. only for a qualifying asset whose effect is material and in that case interest will be added with the asset thereby increasing the value of asset and shown in the balance sheet.
6. As per accounting practice threshold limit which is mentioned in the question itself for determining the capital expenditure for which interest payment will be considered for capitalization and added to asset and shown in the financial statement.   
7. In the above explained scenario the useful life of the capital asset should be more that one year. Capital asset along with interest will be capitalized and will be depreciated over the useful life of the asset.