Your client is in the planning phase of a major plant expansion which will invol

Question

Your client is in the planning phase of a major plant expansion which will involve the construction of a new warehouse. The assistant controller does not believe that interest cost can be included in the cost of the warehouse because it is a financing expense. Others on the planning team believe that some interest cost can be included in the cost of the warehouse but no one could indentify the specific authoritative guidance for this issue. Your supervisor asks you to research this issue.

Required: Research the FASB Codification and draft a professional memorandum that is responsive to the following questions posed by your client:

• Is it permissible to capitalize interest into the cost of assets?

• What are the objectives of capitalizing interest? (i.e. be sure to address the differing accounting treatment—(1) interest is treated as a financing expense vs. (2) interest is capitalized into the cost of the asset.)

• Which assets qualify for interest capitalization?

• Is there any limitation on the amount of interest that may be capitalized in a particular period?

• If interest capitalization is allowed, what disclosures are required?

Explanation / Answer

1. It Is permissible to captalize intrest into cost of assets if the assest is qualified asset. To be qualified asset it should take substantial amountif time to ready for its intended use or sale. Therefore the construction of the warehouse takes substantial amount of time to be ready therfore it is qualified to be capitalize the intrest cost to the assets.

2. If the cost of intrest is capitalize then the assets will shoe correct value in the balance sheet rather then debiteing the value of intrest to the Profit and loss Statement that will undervalue the company because the profits will be reduced thwn the actual profits and the value of the assets will be undervalued in the balance sheet.

3. The Assets that qualify for intrest capitalization is those assets that takes substantial period of time to get ready for its intended use or sale.

4. There is limitation on the capitalizing the intrest cost but the intrest cost that should be allowed to be capitalized should be the intrest cost recognized on borrowings and other obligations that measn the amount capitalized is to be an allocation of the intrest cost incurred during the year to complete the assets.

5. If the intrest is capitalized then the financial statement should disclose that

1. the accounting policy adopted for borrowing cost and

2. the amount of borrowing cost is capitalized during the period.

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