Jane Construction Company is building an office building for speculative purpose

Question

Jane Construction Company is building an office building for speculative purposes. That is, the Company has not yet found a buyer for the building, but expects to do so within a few months. Jane, who expects to spend about another two years to complete construction of the building, asks you, his accountant, if interest and property taxes associated with this construction site should be capitalized or expensed. At what rate of interest should Jane use, if any, to capitalize any interest costs? You must cite the appropriate source from the FASB Codification in your response.

Explanation / Answer

Answrer: Qualifying assets include assets under construction for the firm's own use (such as buildings, machinery) and assets under construction for sale or lease as part of discrete projects (such as real estate projects).

Office building is a Qualifying Asset.

The capitalization period begins when all three of the following conditions have been met:

(1) Expenditures for the asset have been made (i.e., the firm has made cash payments or has incurred debt for construction of the asset).

(2) Necessary activities to get the asset ready for its intended use are in progress (i.e., actual construction work is taking place).

(3) Interest cost of some kind is being incurred (i.e., the firm has some type of interest-bearing debt outstanding). This debt need not be specific debt incurred on the asset. It may be general debt such as bonds payable. Therefore a company may capitalize interest cost even though the entire construction cost of the asset was paid for in cash, so long as the company has some type of interest-bearing debt outstanding.

The capitalization period ends when any one of these three conditions is no longer being met.

So interest cost should be capitalized. In order to determine the interest cost associated with these expenditures, it is necessary first to compute the weighted-average accumulated expenditures. This figure is an "average" or "annualized" quantity representing the average amount of funds tied up in construction throughout the year.

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