Hello, I wanted to ask if I understand Fas 34 properly in that interest is capitalized whenever an asset is acquired of it only applies to self-constructed assets.
Re:
One can look at this issue two ways. From a principles based perspective, capitalization occurs only if the acquisition process takes a considerable amount of time. Thus, if a firm acquires a ready-made asset, it commonly does not spend a long enough period installing and breaking-in the asset to warrant interest capitalization.
On the other hand, if it self-manufactures the asset, the time period can be considerable and not capitalizing interest would materially distort the asset’s true acquisition cost. One can also take a rules based approach. Under this approach, one would read SFAS 34.9, which states: “Interest SHALL BE CAPITALIZED for the following types of assets ("qualifying assets"): “a. ASSETS THAT ARE CONSTRUCTED OR OTHERWISE PRODUCED FOR AN ENTERPRISE'S OWN USE (including assets constructed or produced for the enterprise by others for which deposits or progress payments have been made) “b. Assets intended for sale or lease that are constructed or otherwise produced as discrete projects (e.g., ships or real estate developments). “c. Investments (equity, loans, and advances) accounted for by the equity method while the investee has activities in progress necessary to commence its planned principal operations provided that the investee's activities include the use of funds to acquire qualifying assets for its operations.”
According to this approach, it is clear that SFAS 9.a prescribes interest capitalization whenever a company self manufactures and asset.
Also, SFAS 10 states: “…interest cost shall not be capitalized for inventories that are routinely manufactured or otherwise produced in large quantities on a repetitive basis BECAUSE, IN THE BOARD'S JUDGMENT, THE INFORMATIONAL BENEFIT DOES NOT JUSTIFY THE COST OF SO DOING.“ This means that if an automobile manufacturer manufactures a automobile for its own use, it will not capitalize interest (because these assets are routinely manufactured or otherwise produced in large quantities).
On the other hand, if a construction company constructs a building for its own use, it will capitalize interest because this asset is not routinely produced in large quantities (the same logic would be applicable to, for example, ship buildings or similar companies that produce one-off goods). This paragraph also implies that if a company purchases a ready made asset which requires a considerable amount of installation, it would treat the installation as a self-manufactured which would allow it to capitalize interest (but only with respect to the costs of the installation itself). This logic is supported by 97-2 and 98-1, which consider software requiring significant installation and modification (such a s a management information system) to be accounted for as a project, which also includes capitalized interest.