The Specific Interest Method in Accounting

The specific interest method details how to apply interest paid on long-lived assets toward a business tax deduction. The Financial Accounting Standards Board, the U.S. authority on generally accepted accounting principles, allows businesses to extend tax deductions for interest payments on assets that have a lengthy lifespan, such as real estate, buildings and heavy machinery. This method allows businesses to spread the impact of interest payments on big-ticket items over several tax years.

The technique that makes the specific interest method so useful is interest capitalization. Interest capitalization allows business owners to take their interest payments on a project and add those payments to the cost of the project. With interest capitalization, the interest payments no longer appear as an expense on their current income statement. These interest payments will become a part of the asset's cost as shown on the company's balance sheet and will be included in the asset's depreciation expense in future income statements.

In 1979, the Financial Accounting Standards Board issued Statement 34, which qualified the use of the specific interest method. Businesses can apply the specific interest method only on assets that require an extended period of time to prepare them for their specified tasks. These assets can include production facilities, office buildings and other construction projects. The specific interest method cannot be applied on assets that can be produced in a short time frame or those that can be easily replicated.

Say a company plans to build a $750,000 facility, with construction planned to start January 1 and be completed January 1 of the next year. The company will borrow the funds at an interest rate of 6 percent and will make three equal payments on January 1, May 1 and September 1. The specific interest method allows the company to capitalize interest payments of $15,000 on the first payment ($250,000 x 6 percent x 12 months), $10,000 on the second payment ($250,000 x 6 percent x 8 months) and $5,000 on the third payment ($250,000 x 6 percent x 4 months), for a total interest capitalization of $30,000.

When companies have multiple projects going at once, with multiple loans and different interest rates, they may choose to calculate interest capitalization by either the specific interest method or a weighted average of the interest payments. The specific interest method capitalizes the interest on each individual loan, while the weighted average method combines all the debt and averages the interest payments on each loan to determine a weighted average interest rate.