Question

If a company builds physical facilities for a long period of time from loan funds, can the interest on the loan funds that we use to build the physical facilities be recognized as building assets and or as interest expense? Why?

Answer 1

The interest on the loan funds that a company uses to build physical facilities for a long period of time can we use to build the physical facilities is treated as capitalized interest and should not be recognized as the interest expense in the year(s) in which it is paid. Since many companies finance the construction of their long-term assets with loan funds, Generally Accepted Accounting Principles (GAAP) permits the businesses to avoid expensing interest on such debt by including it on their balance sheets as part of the historical cost of such long-term assets.

Interest that is incurred for the building of physical facilities intended for use over long periods is not deductible at the time that it is paid. This type of interest is instead added to the cost basis of the asset for which it has been incurred. It is called the capitalized interest because it is the cost of borrowing to acquire or construct a long-term asset. Capitalized interest becomes a part of the historical cost of the asset that benefit a company over a long-term. Such interest will show  on a company's income statement in installments through the periodic depreciation expense recorded over the useful life of the long-term asset. Examples of long-term assets for which interest is generally capitalized are real estate, ships, Apartment blocks,  production facilities, etc.