What is capitalized interest?

Capitalized interest is the cost of borrowing to obtain a long-term asset. Unlike typical interest expenses, capitalized interest is not expensed immediately on a company's income statement. Because many companies finance long-term assets with debt, companies are allowed to expense the assets over the long term.

Why is capitalizing interest important?

Capitalizing interest helps a user of financial statements, from the perspective of accrual accounting, to better allocate costs to earnings in the periods when an acquired asset is being used and obtain an accurate measure of the acquisition cost of an asset.

How does a company capitalize interest?

The company capitalizes interest by recording a debit entry of $500,000 to a fixed asset account and an offsetting credit entry to cash. At the end of construction, the company's production facility has a book value of $5.5 million, consisting of $5 million in construction costs and $500,000 in capitalized interest.