A company is constructing a qualifying asset. Its weighted-average accumulated expenditures for the period are $2,000,000. It has a specific construction loan of $1,200,000 outstanding at a 6% interest rate, and other general outstanding debt at a weighted-average rate of 8%. Total interest cost actually incurred by the company during the period, across all of its debt, is $150,000. Under ASC 835-20, how is the avoidable interest to be capitalized this period computed and limited?
- Avoidable interest equals the full $150,000 of interest actually incurred, because ASC 835-20 requires capitalizing all interest cost incurred during a period in which a qualifying asset is under construction
- Avoidable interest equals $2,000,000 multiplied by the 8% weighted-average rate on general debt, applied to the entire weighted-average accumulated expenditures balance, with no consideration of the specific construction loan
- Avoidable interest equals $2,000,000 multiplied by a single blended rate combining the 6% and 8% rates without regard to which portion of expenditures is covered by the specific borrowing, and the result is not subject to any ceiling
- Avoidable interest equals the 6% specific-borrowing rate applied to $1,200,000 of the weighted-average accumulated expenditures, plus the 8% weighted-average rate on general debt applied to the remaining $800,000, with the resulting amount capped at the $150,000 of interest actually incurred during the period
Why D? And why not the others?
Correct answer: D. Avoidable interest equals the 6% specific-borrowing rate applied to $1,200,000 of the weighted-average accumulated expenditures, plus the 8% weighted-average rate on general debt applied to the remaining $800,000, with the resulting amount capped at the $150,000 of interest actually incurred during the period
ASC 835-20-30 computes avoidable interest — the interest that theoretically could have been avoided if the expenditures on the qualifying asset had not been made — by applying a capitalization rate to weighted-average accumulated expenditures (WAAE). The rate hierarchy gives priority to any borrowing specifically incurred to finance the asset: the specific borrowing's rate is applied first, to the portion of WAAE up to the amount of that specific borrowing, and the weighted-average rate on the entity's other (general) outstanding debt is applied to any remaining WAAE in excess of the specific borrowing. Here that is $1,200,000 at 6% plus the remaining $800,000 at 8%. Whatever the computed avoidable interest amount is, it can never exceed the total interest cost the entity actually incurred during the period — that ceiling exists because a company cannot capitalize more interest than it truly paid or accrued. The option capitalizing the full $150,000 regardless of computation ignores the avoidable-interest concept entirely and treats capitalization as automatic rather than computed. The option applying only the general 8% rate to the entire WAAE ignores the required priority given to the specific construction borrowing's own rate for the portion of expenditures it covers. The option using an undifferentiated blended rate with no ceiling both invents an incorrect blending methodology and omits the mandatory cap against actual interest incurred.
Source: FASB ASC 835-20-30 (determining the capitalization rate and computing avoidable interest, including the ceiling on capitalized interest)