Clay Company started construction of a new office building
on January 1, year 4, and moved into the finished building on July
1, year 5. Of the building’s $2,500,000 total cost, $2,000,000 was
incurred in year 4 evenly throughout the year. Clay’s incremental
borrowing rate was 12% throughout year 4, and the total amount
of interest incurred by Clay during year 4 was $102,000. What
amount should Clay report as capitalized interest at December 31,
year 4?

(a) The requirement is to calculate the amount of capitalized
interest at 12/31/Y4. The requirements for capitalization
of interest are met if: (1) expenditures for the asset have
been made, (2) activities that are necessary to get the asset ready
for its intended use are in progress, and (3) interest cost is being
incurred. The amount to be capital-ized is the lower of avoidable
interest or actual interest. Avoidable interest is the average accumulated
expenditures multiplied by the appropriate interest
rate or rates. Since $2,000,000 was spent on the building evenly
throughout the year, the average accumulated expenditures were
$1,000,000 ($2,000,000 ÷ 2) and the avoidable interest was
$120,000 ($1,000,000 × 12%). Since actual interest ($102,000)
is less than avoidable interest, the actual interest cost is capitalized.