Question

41. Which of the following statements is true regarding capitalization of interest?

a. Interest cost capitalized in connection with the purchase of land to be used as a building site should be debited to the land account and not to the building account.
b. The amount of interest cost capitalized during the period should not exceed the actual interest cost incurred.
c. When excess borrowed funds not immediately needed for construction are temporarily invested, any interest earned should be recorded as interest revenue.
d. The minimum amount of interest to be capitalized is determined by multiplying a weighted average interest rate by the amount of average accumulated expenditures on qualifying assets during the period.

Answer 1

The true statement about capitalization of interest is that the amount of interest cost capitalized should not exceed the actual interest cost incurred. This reflects proper adherence to GAAP, and the practice influences a company's investment decisions, as interest rates affect the cost of capital and investment levels. The option (A) is correct.

Step-by-step explanation:

The true statement regarding capitalization of interest in this context is that the amount of interest cost capitalized during the period should not exceed the actual interest cost incurred. When a company constructs an asset, it can capitalize not just the costs of materials and labor, but also the interest cost related to funds borrowed to finance the construction. However, the amount capitalized should not be more than what the company has incurred in interest expenses.

For instance, if a company is constructing a building and the actual interest cost paid during that period is $102 million, then only $102 million or less can be capitalized in the building's cost on the balance sheet. Generally accepted accounting principles (GAAP) specify how companies can capitalize interest, to ensure that the capitalized interest is a fair reflection of the cost of constructing the asset.

Additionally, capitalizing interest can impact the investment decisions of the firm, as it affects the cost of capital and ultimately the amount of investment a firm is willing to make. Interest rates influence the company's decision on whether to invest in new assets, and a lower interest rate environment may encourage more investment. Therefore, option (A) is correct.