Capitalizing interest

Let's think philosophically for a moment: what is capitalized interest? Well capitalizing is when something is reported as an asset instead of as an expense. And interest is of course the charge for borrowing money. So capitalizing interest is when a company gets to report the charge they pay on debt (interest) as an asset on the balance sheet instead of an expense on the income statement (capitalize). Only certain situations allow this sort of accounting treatment, and they are addressed in SFAS 34 (paragraphs 9 and 10).

Actual or avoidable interest, that is the question...
As SFAS 34 says, the amount of interest to capitalize is the lower of: actual interest OR avoidable interest. Actual interest is easy: it's the actual interest rate a business pays for capitalizable debt. Avoidable interest is a little tricker because it's calculated. It's the average accumulated expenditures times the incremental borrowing rate. Remember that in accounting, averages are calculated as the beginning balance plus the ending balance divided by two. Also remember to pick the lower of the two.

Remember that whichever rate you use, you can only capitalize up until the moment that asset is ready for use. Once it goes into use, starting expensing that interest just like all other interest.