FAR · Select balance sheet accounts · 6 practice questions
Capitalized Interest: WAAE, Rates, and Timing
Capitalize the lesser of avoidable interest and actual interest incurred during the eligible construction period. Below: a worked WAAE calculation, specific and general borrowing rates, and free practice.
Try one first
Hint
First calculate time-weighted (weighted-average accumulated) expenditures, then remember GAAP applies interest on specific construction debt first and imputes a rate for any remaining WAAE funded by general borrowings.
Answer A. Compute weighted-average accumulated expenditures: 1,000,000*(12/12) + 600,000*(9/12) + 400,000*(3/12) = 1,550,000. Capitalize interest on the specific construction loan first: 700,000 * 6% = 42,000; the remaining WAAE (1,550,000 - 700,000 = 850,000) is funded by general borrowings at 8% → 850,000 * 8% = 68,000. Total capitalized interest = 42,000 + 68,000 = 110,000.
Why not B: Tempting because 1,550,000 * 8% = 124,000, but GAAP requires using the specific construction loan rate first and only imputing the general borrowing rate to the excess WAAE.
Why not C: This equals total interest actually incurred (42,000 on the specific loan plus 160,000 on general debt) but GAAP limits capitalization to avoidable interest attributable to construction, not all interest incurred.
Why not D: This is interest only on the specific construction loan; it's insufficient when WAAE exceeds the specific loan balance because additional interest attributable to general borrowings must be capitalized.
Worked example
Maple Co. builds a qualifying factory from January 1 through December 31, Year 1, when it is ready for use. Work continues throughout. Payments: $800,000 January 1; $480,000 April 1; $160,000 October 1. All debt is outstanding all year: a $500,000 construction loan at 6%, plus general loans of $600,000 at 8% and $600,000 at 10%.
| 1 | Weighted-average accumulated expenditures (WAAE)($800,000 × 12/12) + ($480,000 × 9/12) + ($160,000 × 3/12) | $1,200,000 |
| 2 | Interest using the specific loan rate$500,000 × 6% | $30,000 |
| 3 | WAAE above the specific loan balance$1,200,000 - $500,000 | $700,000 |
| 4 | Weighted-average general debt rate[($600,000 × 8%) + ($600,000 × 10%)] ÷ $1,200,000 | 9% |
| 5 | Interest on excess WAAE$700,000 × 9% | $63,000 |
| 6 | Total avoidable interest$30,000 + $63,000 | $93,000 |
| 7 | Actual interest incurred($500,000 × 6%) + ($600,000 × 8%) + ($600,000 × 10%) | $138,000 |
Maple capitalizes $93,000 as part of the factory's cost, the lesser of $93,000 avoidable interest and $138,000 actual interest.
Check: Split WAAE into $500,000 at 6% and $700,000 at 9%: $30,000 + $63,000 = $93,000, below the $138,000 actual-interest cap.
Key points
- Start only when expenditures, asset-preparation activities, and interest cost are all present.
- Suspend during extended interruptions without significant preparation activities; stop when ready for intended use, even before production starts.
- Capitalized interest increases construction in progress (CIP); the remaining interest is expensed.
How the exam traps you
- Multiplying total construction spending by an annual rate. Time-weight each payment before applying interest rates.
- Blending the specific construction loan with general debt. Use the specific rate first; average only the other debt.
- Capitalizing all interest on the construction loan or all debt. Calculate avoidable interest from WAAE, then cap it at actual interest incurred.
Question 2
Hint
Focus on the event that shows the machine was available for use, not the later event when operations or sales actually began.
Answer C. Depreciation begins when a PPE asset is placed in service, that is, when it is ready and available for its intended use. Because installation and testing were completed and the machine was ready on December 20, Year 1, Ames should begin recording depreciation on that date. The later start of production or of revenue does not delay the placed-in-service trigger.
Why not A: Delivery can be an acquisition milestone, but depreciation only starts once the asset is placed in service. If installation or testing remained incomplete at delivery, the asset was not yet ready for use and depreciation should not begin at delivery.
Why not B: Actual use in production is not required to start depreciation; the trigger is readiness and availability for intended use, not the date of first operational use.
Why not D: Depreciation is not tied to revenue generation. It is based on the asset being placed in service and allocated over its useful life regardless of when it first produces sales.
Question 3
Hint
Identify the three capitalization conditions and choose the date when the last of them first occurs.
Answer D. Under U.S. GAAP, interest capitalization begins when three conditions are present concurrently: (1) expenditures for the asset have been made, (2) activities necessary to get the asset ready for its intended use are in progress, and (3) interest cost is being incurred. Company A met these conditions on March 1 (expenditure Jan 10, interest Feb 1, activities Mar 1), so capitalization begins on March 1.
Why not A: Tempting because the purchase on Jan 10 is an expenditure for the asset; however, at that date interest had not yet been incurred and activities to get the asset ready were not in progress, so not all three capitalization criteria were present.
Why not B: Tempting because interest began on Feb 1 and an expenditure had already occurred; however, the activities necessary to get the asset ready did not begin until Mar 1, so capitalization cannot begin before the activity start date.
Why not C: Tempting because some may believe capitalization waits until materials are physically on site; however, the delivery on Mar 15 occurred after activities had already begun on Mar 1, and capitalization begins when the last of the three required conditions first exists, which is Mar 1 here.
Question 4
Hint
Evaluate the start date, any suspension period, and the stop date as three separate triggers.
Answer A. Capitalization of interest begins when (1) expenditures for the asset have been made, (2) activities necessary to prepare the asset for its intended use are in progress, and (3) interest cost is being incurred. Arden did not have borrowings (and therefore no interest cost) before February 1, so capitalization could not begin earlier. Capitalization is suspended during an extended interruption when no significant asset-preparation activities occur (the strike), and it ends when the asset is substantially complete and ready for its intended use (January 20, 20X6), not when production actually begins.
Why not B: This choice correctly recognizes that early site grading and design are qualifying activities and that capitalization stops at substantial completion with a suspension for the strike, but it is wrong because Arden had no borrowings before February 1. Without interest cost being incurred before that date, interest cannot be capitalized.
Why not C: This distractor relies on the mistaken shortcuts that capitalization only begins with visible physical construction and that it continues until operations commence. Under GAAP, qualifying activities include site preparation and design work that began earlier, and capitalization ends when the asset is substantially complete and ready for use, not when production begins.
Why not D: This option correctly identifies February 1 as the start because interest began then, but it is wrong because GAAP requires suspension of capitalization during an extended interruption when no significant preparation activities occur (the strike), and capitalization ends at substantial completion on January 20, 20X6, not at the start of production.
Question 5
Hint
Determine when the three capitalization conditions (expenditures made, activities to ready the asset in progress, and interest being incurred) were first all met for the start date, and identify when the facility was capable of operating for its intended purpose (not when every cosmetic finish was completed) for the stop date.
Answer A. Under U.S. GAAP (ASC 835-20), capitalization of interest for a self-constructed asset begins when three conditions are all met: (1) expenditures for the asset have been made, (2) activities necessary to get the asset ready for its intended use are in progress, and (3) interest cost is being incurred. Those conditions first occurred on March 1, Year 1 (first construction expenditures while interest was accruing), so capitalization begins then. Capitalization ceases when the asset is substantially complete and ready for its intended use, here, July 1, Year 3, when limited commercial production and shipments began even though minor nonessential finishing work remained.
Why not B: Tempting because interest began accruing when the loan was obtained and because waiting until every task is finished feels safe. Wrong because mere borrowing does not start capitalization, GAAP requires actual expenditures and necessary preparatory activities to be in progress, and capitalization ends when the asset is substantially complete and ready for use, not necessarily when every cosmetic or nonessential task is finished.
Why not C: Tempting because the start date is correct, and one might assume capitalization continues until all construction, including nonessential finishings, is complete. Wrong because GAAP requires stopping capitalization when the asset is substantially complete and ready for intended use; minor nonessential finishing work does not extend the capitalization period.
Why not D: Tempting because trial production is a visible milestone and may appear to mark the start of capitalizable activity. Wrong because trial runs typically occur after earlier construction expenditures and preparatory activities; capitalization begins when expenditures and necessary activities are first underway (March 1, Year 1), not only when trial production begins.
Question 6
Hint
Identify the earliest date when (1) construction-related expenditures occur, (2) activities to get the asset ready are in progress, and (3) interest is being incurred; then apply the 'available for use' rule for depreciation start.
Answer D. Under US GAAP, avoidable interest is capitalized when three conditions are met: (1) expenditures for the asset have been made, (2) activities to get the asset ready are in progress, and (3) interest cost is being incurred. Those three conditions first coincide on Feb 1, Year 1 (site clearing/demolition expenditures while interest is accruing), so interest capitalization begins then. Depreciation starts when the asset is available for its intended use, Mar 31, Year 2, when installation and final testing are completed.
Why not A: Tempting because interest accrues from the loan date, but capitalization requires qualifying construction expenditures and active progress in addition to interest. Those expenditures/activities did not begin until Feb 1, so capitalization cannot start on Jan 15.
Why not B: Incorrect: GAAP requires capitalization of avoidable interest when the three capitalization conditions are met, which occurs beginning Feb 1, Year 1 in this fact pattern. Depreciation begins when available for use (Mar 31), not when production begins Apr 1.
Why not C: Attractive because major on-site construction is a clear milestone, but capitalization begins earlier when qualifying expenditures and activities to get the asset ready commence (Feb 1). Also, depreciation begins when the asset is available for its intended use (Mar 31), not necessarily on the first production day.
Common questions
How do you calculate WAAE for capitalized interest?
WAAE means weighted-average accumulated expenditures. For a full-year calculation, multiply each construction outlay by its eligible months divided by 12, then add the results.
What interest rate do you use for capitalized interest?
Apply the specific construction loan rate first, up to its balance. Apply the weighted-average rate on other debt to excess WAAE; exclude the specific loan from that average.
When does interest capitalization start and stop?
Start when expenditures, preparation activities, and interest costs are all present. Suspend for extended interruptions without significant preparation work, and stop when the asset is ready for intended use.
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