Capitalized Interest
Candlefocus EditorThe capitalization of interest can be likened to adding the financing cost to the purchase price of an asset in order to pay for it over time. An example that helps to illustrate this concept is the purchase of a car. When you buy a car, you are essentially paying for the cost of the car over a period of time. The amount that you pay per month is the combination of the cost of the car and the financing cost of the loan. This same concept holds true when it comes to capitalized interest.
When a company purchases a long-term asset, such as a building, it typically uses a loan to finance the cost of the asset. In such a case, the principal and interest payments on the loan are both added to the cost of the asset. As the payments are made on the loan, they reduce the cost of the asset over time. This reduction in the cost of the asset is what is referred to as capitalized interest.
Capitalized interest can benefit a company in several ways. First, it enables the company to spread the cost of the asset over a period of time, making it easier for the company to manage its cash flow. Additionally, capitalizing the expense can help the company to spread out the tax implications of purchasing the asset across multiple tax years.
Capitalized interest can be a great tool for companies that need to finance long-term assets. While it may initially appear to increase the cost of the asset, it is important to consider the advantages that it offers in terms of cash flow and the tax implications of the purchase. With a proper understanding of capitalized interest, companies can be better prepared to finance and manage their long-term assets.