....Week 7 Pre-Assignment Part 1 Interest Capitalization The concept is that if you had an asset constructed and paid for it upon completion, the cost would include interest. .Thus, interest a company incurs during construction can be added to the cost of the asset. Interest that would have otherwise been an expense of the period is cost of the asst. Building the "base" to which interest is applied: Interest is applied to cost of land during construction period. Application starts the day construction starts and end on date of completion. Interest is applied to construction expenditures during construction period from date of expenditure to date of completion. Land and expenditures are "annualized". For example, $600,000 spent on June1 and where project is completed October 1 would be $500,000 x 4/12 $200,000. Applying Interest Loans are also annualized. A $200,000 loan that starts on April 1 and is paid off on October 1 at 6%. Would be $200,000 X 6/12-$100,000. The interest would be $1 00,000 X 6% = $6,000. Interest is first applied on construction loans at the applicable rate. The limit on interest capitalized is the "base" (the annualized expenditures on asset) If there is remaining base, interest is applied at the weighted average interest rate on all other debt during the period. Again, the limit is the "base" . Try working the following example: First, build the "base" based on the following expenditures during 2016: Date of expenditure Jan 1 June 1 Oct 1 Completion Item Amount date Oct 1 Oct 1 Oct 1 Land Expenditure1 Expenditure 2 $240,000 840,000 400,000 Second, apply interest to the base, construction interest first. Here are the loans: Start date Date repaid Loan 6/1/20161 10/1/2015 10/1/2017 Rate Amount 11/1/2016 Construction 1096 | $550,000 890 I 1,000,000 General 86