Which of the following is the recommended approach to handling interest incurred in financing the construction of property, plant and equipment?
(A) Charge construction with all costs of funds employed, whether identifiable or not.
(B) Capitalize interest costs equal to the prime interest rate times the estimated cost of the asset being constructed.
(C) Capitalize only the actual interest costs incurred during construction.
(D) Capitalize no interest during construction.
Interest refers to a quantity paid to a lender on the financed amount. Higher interest rates are preferable to lenders while borrowers seek lower interest rates. Typically interest is paid periodically over the life of the debt instrument. The manner by which interest is recorded depends on the purpose of the loan.
Answer and Explanation:
The correct answer is (C) Capitalize only the actual interest costs incurred during construction.
Interest which accumulates on a loan used for the construction a building or other fixed asset is known as construction interest. Unlike normal interest which is expensed as incurred and reduces taxable income, construction interest is capitalized as part of the asset. This interest is recovered later through depreciation.
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from Financial Accounting: Help and ReviewChapter 5 / Lesson 18