Capitalized Interest

What it is

Capitalized interest is interest incurred to acquire or construct a long-term asset that is added to the asset’s cost basis on the balance sheet instead of being expensed immediately on the income statement. The capitalized amount becomes part of the asset’s historical cost and is recognized over time through depreciation (or amortization) over the asset’s useful life.

Key takeaways

• Capitalized interest is interest related to the purchase or construction of long-lived assets and is included in the asset’s capital cost.
• It is not expensed immediately; it appears later as depreciation expense.
• Capitalizing interest follows the matching principle, tying costs to the periods when the asset generates revenue.
• In the long run, capitalized interest and immediately expensed interest have the same total effect on earnings — the difference is timing.

How it works (accounting treatment)

When interest qualifies for capitalization, a company debits the related fixed-asset account and credits cash or a liability for the interest amount. That added cost is depreciated over the asset’s useful life, which spreads the expense into future reporting periods instead of recognizing it all at once.

Capitalization is generally allowed for assets under construction (e.g., buildings, production facilities, ships) and for certain investments while specific activities occur. It is not permitted for repetitively manufactured inventory.

Capitalized interest vs. expensed interest vs. accrued interest

• Expensed interest: Recognized immediately on the income statement as an interest expense.
• Capitalized interest: Added to an asset’s cost and recognized later via depreciation/amortization. Recognition depends on materiality and accounting rules.
• Accrued interest: Interest that has accumulated but hasn’t been paid. Accrued interest becomes capitalized only if accounting rules permit adding it to the principal or asset cost; otherwise it’s recorded as an expense or liability.

When to capitalize interest

Interest is typically capitalized when:
* It is incurred during the construction or production of a qualifying long-term asset, and
* The impact on financial statements is material.

Timing and eligibility vary by transaction type (commercial construction vs. student loans) and by applicable accounting standards and tax rules.

Why companies capitalize interest

Companies may capitalize interest to:
* Match costs with the revenues the asset will generate (matching principle).
* Defer interest expense to periods when the asset is in use and producing income, which can be beneficial for tax or earnings presentation.

How to calculate capitalized interest

Calculate interest the same way as any other interest:
1. Determine the applicable interest rate and the principal balance for the period.
2. Multiply the rate by the principal for the period (adjusting for days outstanding if necessary).
3. Add the calculated interest amount to the asset’s cost basis.
Over time, include the added amount in depreciation or amortization calculations.

Numerical example

A company builds a production facility with construction costs of $5,000,000 and borrows to fund the project at 10% interest. Construction takes one year, producing $500,000 of interest that qualifies for capitalization.

Accounting at completion:
* Fixed asset (capitalized cost) = $5,000,000 + $500,000 = $5,500,000

If depreciated straight-line over 20 years:
* Annual depreciation = $5,500,000 / 20 = $275,000
* Portion attributable to capitalized interest = $500,000 / 20 = $25,000 per year

Capitalized interest and student loans

For many student loans, interest can accrue during periods of deferment and then be capitalized (added to the principal). When interest is capitalized on a student loan:
* The principal increases, and future interest accrues on the higher balance (interest-on-interest).
* Some loans (or borrowers with subsidized loans) do not accrue interest during deferment; terms vary by loan type and program.

Borrowers should understand their loan’s deferment and capitalization rules to estimate repayment amounts accurately.

Bottom line

Capitalized interest places borrowing costs into an asset’s cost base and defers recognition of the expense until the asset is depreciated. It aligns cost recognition with the asset’s revenue generation but increases the asset’s book value — and, in the case of loans, can increase the principal balance and future interest charges.