The capitalization of interest is one of those accounting concepts that, although technical, have a direct impact on the valuation of the assets of a company and on the presentation of its financial statements. Knowing when it is appropriate to incorporate financial expenses as the greater value of an asset, rather than registering them directly as an expenditure of the financial year, is fundamental to comply with accounting regulations and faithfully reflect the economic reality of the business. In this article we explore in depth what is the capitalization of interest in accounting, when it is mandatory and how it should be applied correctly.
What are financial expenses and interest capitalization?
The financial expenses are the costs that a company assumes as a result of using financing from others for its activity. They mainly include the interest and fees earned on bank loans, loans, lines of financing or any other debt owed to third parties.
Under normal conditions, these costs are recorded directly in the profit and loss account the financial year in which they are accrued, reducing the result of the period. However, the accounting rules provide for an important exception: where the financing is intended to acquire, manufacture or construct certain assets which require a long period of time to be operational, the interest can — and in certain cases should — capitalization.
The Capitalisation of interest on accounting is to incorporate these financial expenses as a higher value of the asset in question, rather than directly bringing them to expenditure; thus, the cost of the asset increases and those interest will be progressively charged to results through the amortization of good.
Requirements for interest capitalisation
Not all financial expenses can be capitalised. 2nd Standard of Registration and Valuation of the General Accounting Plan and the IAS 23 (International Accounting Standard) lays down specific conditions to be met for capitalisation to be appropriate:
Construction period exceeding one year
The fundamental requirement is that the fixed I need a period exceeding one year If the process of acquisition, manufacture or construction is completed in less than twelve months, interest should be recorded as financial expenditure for the financial year.
This rule applies both to fixed material (buildings, installations, machinery) stocks whose production process exceeds the year, as is the case in sectors such as construction or real estate promotion.
Directly attributable funding
The financial costs should be directly related with the acquisition, manufacture or construction of the asset. This includes:
- Specific funding: Loans obtained specifically to finance the specific asset.
- Generic funding: Non-specific debts which, in proportion, have been used to finance the asset. weighted average interest rate to calculate the capitalised amount.
Assets eligible for capitalisation
Not all assets allow interest capitalisation. eligible assets Those who need a substantial period of time to be ready for use or sale are excluded:
- Financial assets
- Short-term manufactured stocks
- Assets already completed and ready for use or sale
Capitalisation period
Capitalization can only take place from the beginning of the asset preparation activities (including prior technical and administrative work) until the asset is operating conditions. It is understood that an asset is ready when it can produce yields regularly after the test period.
Interruption and suspension of capitalization
The regulations provide for special situations affecting the capitalization process:
Interruption of activities
If the works or the production process is paralyze for a prolonged period for unsubstantiated reasons (financial, administrative or any cause that suspends the necessary activities), Cease capitalisationDuring that time, financial expenses will be recorded directly as expenditure for the financial year.
However, no interruption is considered when it occurs Temporary delays required as a normal part of the construction or production process. For example, seasonal stops in civil works due to adverse weather conditions do not interrupt capitalization.
Special cases: land and land
One relevant aspect is the treatment of land and landAccording to the sectoral adaptation rules for real estate companies, if there is a time lag between the acquisition of the land and the commencement of construction works, this period is considered to be interruption and it is not appropriate to capitalize on the financial costs associated with the field during that phase.
Calculation of the amount to be capitalised
The calculation of capitalised interest requires specific technical criteria:
With specific funding
If you have obtained a specific loan for the asset, the amount to be capitalised shall be that of the actual costs that the loan was incurred during the financial year, less the yields obtained by the temporary investment of these funds as long as they have not been applied to the asset.
This means that if, for example, a loan is obtained but the funds are temporarily held in a term taxation by generating interest, only net financial expenses (costs minus financial revenues) will be capitalized.
With generic funding
Where there is no specific funding or where a combination of own funds and other funds is used, an estimate of the weighted average interest rate applicable to the part of the asset financed from generic third party resources.
The procedure is as follows:
- Determining the total Debts (excluding commercial debts)
- Calculate the total of financial expenses Accrued from those debts
- Get the average interest rate linking both magnitudes
- Applying this type to the amount of non-specific non-other-fund-funded assets
Accounting reflection of capitalisation
Once the amount to be capitalised has been calculated, the accounting record may be carried out in two ways depending on the relevance of the amount:
If the amounts are significant, the revenue account is used ‘Incorporation into financial expenditure assets’, which offsets the recognised financial expenditure in the profit and loss account. in progress or of the stocks in production.
If the amounts are not material, can be recorded directly as higher asset value without the need to create the income offsetting item.
Limits and precautions
The capitalization of interests has a ceiling: can never overcome the market value If the total cost of the asset (including capitalised interest) exceeded its fair value, the asset would be overvalued, which contradicts the principle of valuing prudence.
In addition, it is important to remember that interest capitalisation increases the value of the asset and, consequently, the amortization allocations Although it improves the performance of the current period (by reducing financial costs), it increases depreciation costs for future periods.
Conclusion
The interest capitalisation In accounting it is a technique that allows to reflect more accurately the real cost of the assets that require long periods of construction or production. However, its application requires a deep knowledge of the accounting rules, solid technical criteria to determine the capitalised amounts and a rigorous monitoring of the periods of capitalization.
In Afianzaour team of accounting experts helps you determine when the capitalization of financial expenses proceeds, to correctly calculate the amounts according to the current regulations and to make the proper accounting record. Because correctly applying these criteria is not only a matter of regulatory compliance, but of presenting financial statements that faithfully reflect the economic reality of your company.
