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Capitalization of Interest Cost Presented by CSU and KPMG LLP.

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Presentation on theme: "Capitalization of Interest Cost Presented by CSU and KPMG LLP."— Presentation transcript:

1 Capitalization of Interest Cost Presented by CSU and KPMG LLP

2 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 2 Capitalization of Interest Cost FASB Statement No. 34: Established standards for capitalizing interest cost as part of the historical cost of acquiring certain assets. To qualify for interest capitalization, assets must require a period of time to get them ready for their intended use. The interest cost eligible for capitalization shall be the interest cost recognized on borrowings and other obligations. The amount capitalized is to be an allocation of the interest cost incurred during the period required to complete the asset. The amount of interest cost to be capitalized for qualifying assets is intended to be that portion of the interest cost incurred during the assets' acquisition periods that theoretically could have been avoided (for example, by avoiding additional borrowings or by using the funds expended for the assets to repay existing borrowings) if expenditures for the assets had not been made.

3 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 3 Capitalization of Interest Cost FASB Statement No. 34, Continued: Assets Qualifying for Interest Capitalization (“qualifying assets”)” Interest shall be capitalized for the following types of assets ("qualifying assets"): –Assets that are constructed or otherwise produced for an enterprise's own use (including assets constructed or produced for the enterprise by others for which deposits or progress payments have been made) –Assets intended for sale or lease that are constructed or otherwise produced as discrete projects (e.g., ships or real estate developments). The average amount of accumulated expenditures for the qualify assets is then calculated for the year

4 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 4 Capitalization of Interest Cost FASB Statement No. 34, Continued: Interest Rate For Capitalization Purposes (“the capitalization rate”) The capitalization rates used in an accounting period shall be based on the rates applicable to borrowings outstanding during the period. If an enterprise's financing plans associate a specific new borrowing with a qualifying asset, the enterprise may use the rate on that borrowing as the capitalization rate to be applied to that portion of the average accumulated expenditures for the asset that does not exceed the amount of that borrowing. If average accumulated expenditures for the asset exceed the amounts of specific new borrowings associated with the asset, the capitalization rate to be applied to such excess shall be a weighted average of the rates applicable to other borrowings of the enterprise. The amount capitalized in an accounting period shall be determined by applying the capitalization rate to the average amount of accumulated expenditures for the asset during the period.

5 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 5 Capitalization of Interest Cost FASB Statement No. 34, Continued: The Capitalization Period The capitalization period shall begin when three conditions are present: a.Expenditures (as defined in paragraph 16 of FASB No. 34) for the asset have been made. b.Activities that are necessary to get the asset ready for its intended use are in progress. c.Interest cost is being incurred. The capitalization period shall end when the asset is substantially complete and ready for its intended use.

6 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 6 Capitalization of Interest Cost FASB Statement No. 62 amends FASB Statement No. 34 as follow: Requires capitalization of interest cost of restricted tax- exempt borrowings less any interest earned on temporary investment of the proceeds of those borrowings from the date of borrowing until the specified qualifying assets acquired with those borrowings are ready for their intended use. Prohibits capitalization of interest cost on qualifying assets acquired using gifts or grants that are restricted by the donor or grantor to acquisition of those assets.

7 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 7 Four Key Categories Campus needs to determine if the capitalization of interest is required for projects that are contained in its Construction Work in Progress (CWIP) accounts. CWIP accounts can be broken out into 4 key categories: 1) Projects acquired using gifts, grants or State of California capital appropriations 2) Projects funded with taxable debt 3) Projects funded with tax-exempt debt 4) Projects that are self-funded by the campus with multiple funding sources

8 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 8 Category 1 1) Projects acquired using gifts, grants or State of California capital appropriations No interest capitalization required * *Paragraph 5 of FASB No. 62 amended FASB No.34 and added the following sentence to paragraph 10 of FASB 34 which specifies the types of assets for which interest is not capitalized: (f) Assets acquired with gifts and grants that are restricted by the donor or grantor to acquisition of those assets to the extent that funds are available from such gifts and grants.

9 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 9 Category 2 2) Projects funded with taxable debt Determine qualifying assets, capitalization rate and capitalization period (see slides 3, 4 and 5) Determine the amount of interest to capitalize by multiplying the capitalization rate to the average amount of accumulated expenditures for the asset during the period. If the campus associates a specific new borrowing with a qualifying asset, the campus may use the rate on that borrowing as the capitalization rate to be applied to that portion of the average accumulated expenditures for the asset that does not exceed the amount of that borrowing. If average accumulated expenditures for the asset exceed the amounts of specific new borrowings associated with the asset, the capitalization rate to be applied to such excess shall be a weighted average of the rates applicable to other borrowings of the enterprise. Finally, capitalize the interest cost calculated above. Interest capitalization is not required if its effect, compared with the effect of expensing the interest, is immaterial.

10 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 10 Category 2 - Example 2) Projects funded with taxable debt Example (taxable revenue bond) from the passdown schedule Excerpt from campus passdown schedule If campus records as presented in the passdown schedule, then the entry to record the capitalization of interest cost is: DR CWIP $141,360 CR Interest expense ($141,360)

11 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 11 Category 3 3) Projects funded with tax-exempt debt Most likely result in interest capitalization Capitalize interest cost less interest earned until assets are ready for intended use For the portion of interest costs and interest earnings that are related to assets which have been placed in service, entries are recorded as presented in the pass down schedule. For the portion of interest cost and interest earnings that are related to CWIP, campus needs to capitalize such amounts, i.e. to record the net amount as an addition to CWIP.

12 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 12 Category 3 - Example 3) Projects funded with tax-exempt debt (cont’d) Example from passdown schedule –If campus records as presented in the passdown schedule, then the entry to record the capitalization of net interest cost is: DR Investment income $1,458,602 CR Interest expense ($1,134,582) CR CWIP ($324,020) Note: In this entry, the investment earning is greater than the interest expense, which results in a net reduction to CWIP. This example assumes that the qualifying asset is in CWIP during the entire fiscal year.

13 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 13 Category 4 4) Projects that are self-funded by the campus with multiple funding sources Calculate the interest that could have been avoided (avoidable interest) if the qualifying assets on which the interest is based had not been constructed. The amount of interest that is actually capitalized may not exceed the actual interest cost incurred by the campus for the year. No interest capitalization required if immaterial. FASB Statement No. 34 and 62 are not applicable if no debt is outstanding.

14 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 14 Category 4 - Example 2) Projects that are self-funded by the campus with multiple funding sources Assume the construction project X is to be financed through donor contribution, tax-exempt revenue bond at a rate of 5%, and from fees. In the absence of other outstanding debt to compute the average interest rate (Step 2), campus may use the 5% rate to calculate the interest expense. The outstanding debt is assumed to have been outstanding the entire year. Campus’ other outstanding debt during the year consist of $600,000 (CP equipment financing) and $800,000 (Energy conservation project) with interest rates of 4% and 6.5%, respectively. Campus incurred project X expenses as follow: Dec 1$200,000 (bond) March 1$400,000 (donor) June 1$120,000 (fees)

15 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 15 References Financial Accounting Services Training, Education & Development Portal https://zeta.calstate.edu:8250/portal/page?_pageid=74, 1&_dad=portal&_schema=PORTAL https://zeta.calstate.edu:8250/portal/page?_pageid=74, 1&_dad=portal&_schema=PORTAL GAAP Manual P_Manual.shtml P_Manual.shtml

16 August 2008 GAAP Reporting Workshop © 2008 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in U.S.A. KPMG and the KPMG logo are registered trademarks of KPMG International. 16 Questions and Answers How should investment earnings from the operating fund used for capital projects be treated? Investment earnings from the operating fund used for capital projects do not meet the criteria from paragraph 5, FASB 62 as gifts or grants. Therefore, it should be treated as self funded. Should capitalized lease obligations be used in calculating the weighted average rate for self-funded projects? Interest related to a capital lease determined in accordance FASB 13 should be included in the calculation, assuming the interest is related to a qualifying asset. Can SRB financed auxiliary projects for which the campus does not hold the assets, but rather a note or lease receivable be excluded as part of campus’ debt in calculating the weighted average rate for self-funded projects? Given the nature of the SRB financed auxiliary projects which doesn't represent capital asset activity on the University's books and which is offset with a corresponding note receivable between the university and the auxiliary, an argument can be made to exclude the rates on these borrowings from the weighted average rate calculation. Should interest cost be included in the CWIP and allocated to the campus for projects financed by the CO, in which the CO records the debt and passdown the CWIP to the campuses? capitalized interest costs should be allocated to the campus.


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