The rules related to the capitalization of interest costs into the original carrying value of PPE are generally similar under U. S. GAP and IFRS. While there are some differences, most notably in how firms net interest revenue and interest expense, the two standards generally provide similar requirements. The standards for U. S. GAP are found in ASC 835- 20 and the standards for IFRS are found in IAS 23.
a. Read ASC 835- 20- 05, ASC 835- 20- 10 and paragraph 1 of IAS 23. What is the general concept underlying interest capitalization for PPE? What would be the effect of not capitalizing interest into PPE?
b. Baby Strollers Unlimited is building a new factory that it will use to make a new type of baby stroller. It will need to borrow money from a bank to finance the construction. Read paragraphs 5 and 6 of ASC 835- 20- 15 and paragraphs 2 through 5 of IAS 23. Should it capitalize the interest incurred related to the construction of the new factory?
c. Read paragraphs 1 through 5 of ASC 835- 20- 25 and paragraphs 17 and 22 of IAS 23. Over what period should Baby Strollers Unlimited capitalize the interest?
d. Read paragraphs 1 through 6 of ASC 835- 20- 30 to answer the following questions. Paragraphs 8 through 15 of IAS 23 also might be useful.
1. What is the general concept as to what interest should be capitalized?
2. According to ASC 835- 20- 30- 3, the amount of interest to be capitalized is determined by multiplying the weighted- average accumulated expenditures times the capitalization rate. What interest rate should be used to compute the amount of interest to capitalize (i. e., how is “capitalization rate” defined)?
e. Baby Strollers Unlimited (BSU) incurs a total of $ 2 million of expenditures related to its new factory. The factory construction started on January 1 with an initial outlay of $ 200,000. BSU incurs additional costs of $ 550,000 on April 1, $ 750,000 on September 1, and $ 500,000 on October 1. Construction is completed on December 31 and BSU commences using the factory on that day. BSU has a loan of $ 800,000 that is specific for this project with an interest rate of 7%. The loan started on January 1. It also has additional general borrowings, outstanding all year, including a 9% loan with a principal balance of $ 5,000,000 and a 10.5% loan with a principal balance of $ 3,000,000.
1. What is the weighted- average accumulated expenditures related to the factory?
2. What is the appropriate capitalization rate?
3. What amount of interest should BSU capitalize?