An example of capitalized interest is in Curriculum - 3 | Page 474 | Example 2. Because of copyright issues, I have changed the numeric values…
What would be the capitalized interest for a $2M loan at interest rate of 10% for useful life of 3 years? As per curriculum, the answer would be $2M * 10% * 3 years = $600K. I am not sure why curriculum does this because if we set up Amortization table then we see that the total capitalized interest would be $412K and not $600K.
Amortization table is here: https://postimg.org/image/tyzirdbyz/
Can someone please help me?
They’re trying to keep it simple: the point of this example is not to explore loan amortization.
By the way, there’s no reason to assume that the loan is amortized. It could be interest-only payments every year, just as with a bond. Or the interest could accrue until the loan is due.
Good question. Sometimes politicians and instructors says “Good question” as a matter of reflex. In this case, it actually is a very good question. I like your chances of passing L1 and beyond.
That said, I wonder if something got lost in translation with your example. You can capitalize interest incurred during the construction period, but not after. So the development period is relevant, but not the useful life. The principle at play here is that fixed assets should include the direct costs of getting them ready for use, but not ongoing maintenance costs. The interest costs in the out years are maintenance costs and would flow through interest expense.
So I think we would need more information to know the answer to your question.
That’s a great catch, 40yoCFAcandidate! I meant the development period (i.e. the direct cost of getting the asset ready for use) and not the useful life. I apologize about this.