Case Study The CFO of Andarex, Inc. (Ticker symbol ANDX on the NASDAQ) has called the Accounting Manager back into his office to discuss the interest capitalization issue that they discussed a few weeks ago:

CFO: I wanted to let you know that I read your writeup about our last conversation and I really appreciate your words. Sometimes I get a little ahead of myself and Im glad you shared your thoughts. Please ensure that we stop capitalizing interest on that project right away according to your advice.

Acctg. Manager: OK, thank you very much. I will follow up on that immediately.

CFO: I did want to ask you to research something else for me on a different project. Our commercial real estate division is thinking about a new project that is a little unique for us. Do you have time to do some research for me?

Acctg. Manager: Certainly. Could you tell me a little bit about what you are looking for?

CFO: I wrote down a few questions for you. I want to understand what the rules are. Ill just give that to you. Take a look and let me know if you have any questions.

Acctg. Manager: Absolutely. Thank you very much.

The Accounting Manager is thrilled that the CFO respected the advice given regarding the issue they previously discussed. After leaving the meeting, the Accounting Manager consults the CFOs questions about the new project which are detailed in the "Case Study Questions" section.

Case Study Questions

Answer the following three questions. Make sure that each answer is complete and supported.

1. What are the rules for the period of time during which the company should capitalize interest? In other words, when should we start (what conditions need to be met?) and when should we stop?

2. What are the rules for the capitalization rates (interest rates) we should use? For example, if we borrow some of the projects costs in a specific loan and get the rest from cash that we have from our other general borrowings we have made in the past, what interest rate or rates do we use?

3. This project is unique. It is one project with two partsa hotel and a small retail area with shops. The hotel is going to take three years to complete and the retail shops will only take one year to complete. We will be able to open the shops in one year and start earning rent from our tenants. So my question is: Do we just capitalize interest on the whole project for the full three years since that is when the whole project is complete? Or do we split it into parts? What are the rules?