Schweser Capitalization of Interest Costs

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jamespucyk

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I ran across a question in Schweser Qbank that ran something like this and the text and the notes were not too much help and the answer makes me wonder, here goes...

Basically they say the company has loan A, taken out exclusivly for construction, paying interest rate X and the company has a general loan, B, paying out Y interest, how much interest should be capitalize,

The answer is, according to SFAS 34, the capitalize X, which specifically the amount taken out to finance the construction. But schweser insists, in their answer to capitalize X and Y (prorated for the remainder of the cost of construction). I can see their logic, that the loan oustanding was used in someway to pay for the project. But the text is quite clear and SFAS 34 states that is should be capitalized as stated in the text, any ideas?
 
I will add this is all according to what is in the notes and the text and although I am not a professional accountant, I would say that although that may be a proper treatment, this seems to be a clear divergence between schweser and the curriculum.
 
I am only using Schweser.

According to Schweser Notes, the amount to be capitalized is:

Specific Amt * Specific Rate + (Total Construction Cost - Specific Amt) * General Rate.

So in the question, if the Specific Amt A is less than the Total Construction Cost (investment), then part of B needs to be caped as well.

I am not aware of the exact rules regarding this in SFAS 34. Did you see that in the official Curriculum?
 
Plus, I think Schweser says that if you do not specifically borrow money related to construction of the asset, then wieghted average interest rate should be capitalized.
 
Well that's where there is a disconnect. The chapter on capitalization vs expensing clearly states that specific interest used to finance the construction is capitalized OR if there is no specific identifiable interest it should be the weighed average. There is no "capitalize specific interest and/or take the weighed average of the difference" statement contained anywhere. I don't anticipate any question being on th exam in regard to this, but you never know. I see schweser's logic though.
 
I'm sorry, can you please state again what the books (not Schweser) are saying?
 
The CFA materials state that interest based upon specific borrowing for a project should be capitalized OR if specific borrowing can not be identified then it should be the weighed average of the borrow for existing debt. There is a clear delineation here, there is no mention in the text about using the weighed average if the specific borrowing is short to cover the cost of the construction.

The schweser questions are all along the following format: They give you a project say 1 million dollar and state that the company borrowed 500 k to fund it @ 10% interest and they have a bond outstanding for 2 million @ 7% interest. What charge should be capitalized. The answer, according to schwesr is 50K specific to the borrowing plus 35k out of the general borrowing (500k of general debt @7%), so 85K should be capitalized, but this is not what the book states.

But based upon the text with a strict interpertation, only 50K should be capitalized as specific borrowing can be identified. There is no, "if borrowing is short to fund construction, then take the weighed average interest on general debt outstanding for the remainder of the text and capitalize it with the specific borrowing" statement in the text.



Edited 1 time(s). Last edit at Monday, April 24, 2006 at 02:54PM by jamespucyk.
 
So, according to the book, CAP 50K, and the rest would be expensed?

I think CFA material is the exact is taken out of the actual reading books, but I'll go check my Financial Statment text book at home tonight to be sure.
 
Yes, that's how it is worded, there is no mention of any remainder of the cost being capitalized, the wording is explicit.
 
James - I looked up the financial statment book and it has exactly what you stated above.

I think if this question were to arise in the test, I would use the Schweser method.
 
So the rest of the cost that is not identifiable should have a weighed average of interest capitalized, cool.
 
Rest of the cost that is Identifiable should have weighed average right?

1,000,000 for Construction
Borrowed 500,000 @ 8% - Capitalize
Rest 500,000 @ weighted average
 
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