CFA Level IFinancial Statement AnalysisMedium
A company borrows funds specifically to construct a warehouse and incurs $100,000 of interest during the construction period. Under the applicable capitalization rules, how should this interest be treated?
- AIt increases the cost of the warehouse (a long-lived asset) and is not expensed in the current period
- BIt has no effect on any financial statement until the related loan is fully repaid
- CIt is recorded as a reduction of cash flow from financing activities with no income statement effect
- DIt is expensed immediately, reducing net income by $100,000 in the current period
Show answer & explanationAnswer & explanation
Correct answer: A. It increases the cost of the warehouse (a long-lived asset) and is not expensed in the current period
Interest incurred during the construction of a qualifying asset is capitalized as part of the asset's cost rather than expensed, and it is subsequently depreciated over the asset's useful life rather than hitting the income statement immediately.
Why the other options are wrong
- B. Incorrect — it does affect the balance sheet immediately by increasing the asset's carrying value.
- C. Incorrect — it affects the balance sheet asset value, not merely a financing cash flow reduction.
- D. Incorrect — capitalized interest is not expensed during construction.
Capitalized Interest
Interest cost incurred during the construction period of a qualifying long-lived asset is added to the asset's cost rather than expensed on the income statement.
- Applies only during the construction/development period
- Increases asset cost and future depreciation expense
- Once construction ends, further interest is expensed normally
Memory trick: Build first, expense later — capitalize while under construction