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Simple English definitions for legal terms
capitalized interest
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A quick definition of capitalized interest:
Capitalized interest is when a company doesn't immediately report the interest it owes on a loan or asset as an expense. Instead, the interest is added to the total value of the asset on the company's balance sheet. Later, the interest is reported as a depreciation of the asset on the company's income statement. This helps the company reduce its taxes after depreciation. Capitalized interest is only used for long-term assets, like building a headquarters. It's important to note that capitalized interest is different from capitalized accrued interest, which refers to all the interest a company owes on a loan currently.
A more thorough explanation:
Definition: Capitalized interest refers to the interest that is accrued on a long-term asset or loan, but is not immediately reported as an expense on a company's income statement. Instead, the interest is added to the total value of the asset on the balance sheet and is later reflected as a depreciation of the asset on the income statement.
For example, if a company is constructing a new building, they may take out a loan to finance the project. As the construction progresses, interest will accrue on the loan. Instead of immediately reporting this interest as an expense, the company can choose to capitalize it by adding it to the total value of the building on their balance sheet. This can help to reduce taxes after depreciation.
It's important to note that capitalized interest can only be used for long-term assets, such as real estate or equipment, and not for short-term assets like inventory or supplies.
Example: ABC Corporation is constructing a new office building that will cost $10 million. They take out a loan for $8 million to finance the project. As construction progresses, the company accrues $100,000 in interest on the loan. Instead of immediately reporting this interest as an expense, they choose to capitalize it by adding it to the total value of the building on their balance sheet. The building is now valued at $10.1 million ($10 million + $100,000 in capitalized interest). Later, when the building is complete and in use, the company will report the accrued interest as a depreciation expense on their income statement.
This example illustrates how capitalized interest can be used to reduce taxes after depreciation. By adding the interest to the total value of the building, the company can increase the amount of depreciation they can claim on their taxes, which can help to lower their tax bill.