Capitalization of interest costs

In general, interest costs are expensed, exept for a loan taken for construction of a long-lived asset, the interest costs during the construction period can be capitalized. Due to its distortion in income statement, analyst need to adjust.

Rules for capitalization of interest:
· Only the interest incurred during construction period can be capitalized.
· If the firm has no debt, it cannot capitalize any interest costs.
· If a loan has been taken specifically for the construction, only the interest on that loan may be capitalized.
· If no specific loan can be linked to the construction, capitalization must be based on weighted average cost of borrowing.

Adjustment
· Interest Expense adjustment – add capitalized interest (disclosed in footnote) during the year to interest expense
· Depreciation adjustment – deducted the amortized interest in previous years to depreciation expense (may need estimate as the information not disclosed in footnote, ignore if small)
· CF adjustment – add capitalized interest during the year to CFI and substracted from CFO
· Ratio adjustment – eg interest coverage/profitability ratio- should recalculate with restated figures