What is interest expense capitalization? Accounting for interest expense capitalization

What is interest expense capitalization? Learn about interest expense capitalization conditions (CPLV), cases where interest expense is capitalized, and accounting for capitalized interest expense

I. What is capitalization of interest expenses?

Capitalization of borrowing costs (CPLV) is the recording of borrowing costs incurred during the investment in construction or production of unfinished assets into the value of that asset.

According to Accounting Standard No. 16 – Borrowing costs, Article 8 stipulates: 

• Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are included in the cost of that asset;
• Borrowing costs are capitalized when it is probable that the future economic benefits associated with the asset will flow to the enterprise and the costs can be measured reliably.

Accordingly, the conditions for capitalizing interest expenses are:

• The amount of CPLV capitalized must be measured reliably;
• Capitalizing CPLV is certain to gain future economic benefits from the use of assets formed from borrowing costs.

II. Cases of capitalizing interest expenses

1. Case 1: Interest expense used for basic construction investment purposes

Actual borrowing costs incurred during the construction investment process will be capitalized into the investment value. If during the investment period, deposit interest also arises, the deposit interest will be offset against the remaining loan interest and recorded as a reduction in the investment value.

For example:

If your company borrows money to build a factory, the interest expense incurred during the construction phase of the factory will be recorded in the value of the factory. 

In addition, the company does not use all of the borrowed money, but deposits a portion of it in the bank. At that time, the interest on the bank deposit will offset the loan interest. In case it is fully offset with the loan interest for that period, the remaining portion will be recorded as a decrease in the value of the factory.

2. Case 2: Interest expense used to produce unfinished assets

Work in progress is an asset that is under construction or in production and has a production cycle of more than 12 months. Interest expenses incurred during this period will be recorded in the original cost of that asset.

In addition, similar to case 1, if during this period both loan interest and deposit interest arise, the loan interest expense will be offset against the remaining deposit interest and recorded as an increase/decrease in the original value of the asset.

III. How to determine the start – stop – end time of capitalization

1. Time of capitalization initiation

Capitalization of interest expense begins when all of the following conditions are met:

• Borrowing costs incurred;
• Start to incur costs for investment in construction or production of unfinished assets;
• Activities necessary to bring the uncompleted asset to its intended use or sale are in progress (including: construction, manufacturing, installation, etc.).

For example:

Your company borrows money to buy a piece of land and build a factory on that land but has not started construction yet, so it has not been capitalized. 

2. Time of temporary suspension of capitalization

Interest expenses will cease to be capitalized when the investment process of construction and production of unfinished assets is interrupted, unless such interruption is necessary and included in the original plan. 

For example:

If a legal dispute arises during construction, resulting in a temporary suspension of construction, capitalization will be suspended. In this case, interest expense will be recognized as an expense in the period until construction or production activities resume.

3. Time of capitalization termination

• Capitalisation of borrowing costs ceases when activities necessary to prepare the asset for its intended use or sale. Borrowing costs incurred thereafter are recognised as expenses in the period;
• When the process of investment in construction and production of assets is completed in parts or projects and each part/project can be used independently while continuing the investment in construction/production for other parts/projects, the capitalization of interest expenses will end for the loan capital of the completed part/project.

IV. Accounting for capitalized interest expenses

1. When interest expense arises, account for it

• Debit account 241 (for capitalization for construction investment activities);
• Debit account 627 (for capitalization of unfinished asset production activities);
• Credit account 111, 112 (periodic loan interest payment);
• Credit account 242 (in case of interest paid in advance for many periods);
• Credit account 335 (pre-deducted interest expense during the period – if loan expense is paid in advance).

2. Income arising from temporary investment of borrowed capital

Accountant records:

• Debit account 111, 112: Amount received;
• Credit account 241 (for capitalization of construction investment activities);
• There is account 627 (for capitalization of unfinished assets production activities).

3. Borrowing costs relating to uncompleted assets that are abnormally interrupted or from the time of cessation of capitalization

Accounting:

• Debit account 635;
• There are accounts 111, 112, 242, 335.

>> See more: Determining interest expenses when calculating corporate income tax.

V. Frequently asked questions when capitalizing interest expenses