Interest Capitalization
Response to the following problem:
The Gold Creek Company has borrowed large amounts of money to purchase 5,000 acres of land, which it will develop as a new ski area over the next 10 years. Development is currently under way on the first 2,000 acres, with trails being cut and ski lifts being built. When the company completes this initial development after four years, it will develop the remaining acreage at the rate of approximately 500 acres per year. The company also used some of the money it borrowed to purchase adjacent land, which it will use to expand the ski area if it is successful.
Since this is the first year of the company's existence, it has not developed a policy about interest capitalization. Specifically, it is uncertain about whether it is entitled to capitalize interest on the amounts borrowed to acquire the first 2,000 acres, the total 5,000 acres, the 5,000 acres plus the adjacent land, or the land and the development.
Required
1. Explain the interest capitalization that is appropriate under these circumstances.
2. How might the decision be influenced if the company were interested in earnings management?