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Self-constructed assets
Self-constructed assets
Rather than buy an asset, a company could decide to build an asset itself.
Rather than buy an asset, a company could decide to build an asset itself.
Overhead
Overhead
In managerial accounting you learn how to calculate the cost of goods manufactured, which includes direct material, direct labor, and manufacturing overhead costs. Direct material and direct labor can be calculated easily. Overhead, on the other hand, is difficult to measure accurately on a project by project basis. A refresher on manufacturing overhead is provided below.
GAAP treatment
GAAP treatment
GAAP says that overhead costs related to self-constructed assets should be pooled with manufacturing overhead costs and allocated to self-constructed assets based on the relative amount of the cost driver used. GAAP calls this the full-cost approach.
Interest capitalization
Interest capitalization
What types of self-constructed assets qualify for this treatment?
What types of self-constructed assets qualify for this treatment?
GAAP says interest can be capitalized for:
Assets built for the company's own use, or
Assets constructed as discrete projects (e.g., a ship or a real estate development).
When can capitalization begin?
When can capitalization begin?
GAAP says capitalization can begin when construction begins and the first construction expenditure has been made as long as interest costs have actually been incurred.
How much interest should be capitalized based on facts above?
How much interest should be capitalized based on facts above?
Does GAAP require funds to be borrowed specifically for the construction project?
Does GAAP require funds to be borrowed specifically for the construction project?
Answer: No. The only requirement is that the company have some outstanding debt. The assumption being made is that, even if a loan isn't taken specifically for the construction project, the funds used for the construction project could have been used to payoff existing debt. Therefore, the new project used borrowed funds indirectly.
In the example above, the calculation would use a weighted average interest rate - calculated using all outstanding loans - in place of the 8% rate. The weighted average rate would be calculated as follows.
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