Capitalization of borrowing costs

Build a plant with borrowed money, and the interest you pay during construction is, economically, part of the cost of getting it ready. So all three frameworks require you to capitalize borrowing costs on qualifying assets, which are assets that take a substantial period to get ready. In India the rule of thumb is about 12 months. You'll find the rules in IAS 23 / Ind AS 23 and ASC 835-20. Capitalization starts when expenditure, interest and construction activity are all present. It's suspended during extended idle periods and ceases at substantial completion. Routine inventory never qualifies.

How is capitalised interest calculated?

Mechanics. Two layers:

1. Specific borrowings are loans taken for the project. Capitalize the actual interest. Under IFRS/Ind AS you capitalize it net of investment income on temporarily idle funds. US GAAP doesn't permit that netting, apart from rare tax-exempt exceptions, so US capitalized interest runs slightly higher on identical facts.
2. General borrowings get a weighted-average capitalization rate (total interest on general debt ÷ total general debt). Apply it to the average accumulated expenditure that specific loans didn't fund. Total capitalized interest can never exceed the interest actually incurred.

Worked example. Meridian Cements (synthetic, FY April to March) builds a grinding unit. It spends ₹200 crore on 1 April, ₹200 crore on 1 October and ₹100 crore on 1 January.

• Average accumulated expenditure (AAE) = 200×(12/12) + 200×(6/12) + 100×(3/12) = 200 + 100 + 25 = ₹325 crore.
• Specific loan: ₹150 crore at 9% for the full year = ₹13.5 crore of interest. Part of it, ₹50 crore, sat idle for six months earning 6% = ₹1.5 crore of income. Ind AS capitalizes 13.5 − 1.5 = ₹12.0 crore.
• General borrowings: ₹400 crore at 8% (interest 32) and ₹200 crore at 11% (interest 22), so the capitalization rate = 54/600 = 9.0%. AAE funded generally = 325 − 150 = 175, so you capitalize 175 × 9% = ₹15.75 crore.
• Total capitalized: ₹27.75 crore. US GAAP on identical facts gives 13.5 + 15.75 = ₹29.25 crore, because there's no netting. Capitalized interest raises the plant's cost by that amount, and the P&L interest line shows only the uncapitalized remainder.

Why does capitalised interest matter to analysts?

Why analysts care.

• Interest coverage is flattered. EBIT/interest uses the P&L interest line, which excludes capitalized interest. Recompute coverage as EBIT ÷ (interest expensed + interest capitalized), because the cash claim is the full amount. You'll find the capitalized figure in the borrowing-cost or PP&E note.
• EBIT is flattered against an expensing peer. Capitalized interest resurfaces later as depreciation, below the EBITDA line, spread thin.
• Interest hides in capital work-in-progress (CWIP). A project that never commissions keeps absorbing interest without ever producing depreciation. Since its 2021 amendments, India's Schedule III forces a CWIP ageing table (<1, 1 to 2, 2 to 3, >3 years) plus overdue-project disclosure, so read it. A rising >3-years bucket is a classic stressed-balance-sheet tell. Infra and real-estate developers are habitual offenders, and capitalized interest ran through the IL&FS and DHFL post-mortems covered in the forensic case files.