Why Capitalized Interest Can Understate True Borrowing Costs

Capitalized interest is interest that never touches the income statement in the year it's incurred. GAAP requires it under ASC 835-20 for any asset that takes real time to build — a power plant, a pipeline, a fleet of vessels under construction — and the requirement is not optional. Interest cost that would otherwise sit on the interest expense line during construction gets added instead to the asset's cost on the balance sheet, then recovered later through depreciation, spread across decades instead of the year the cash actually went out the door.

The accounting is defensible on its own terms — interest paid to build a plant is, in a real economic sense, part of what the plant cost. The practical effect, though, is that a company financing a large, multi-year construction project can carry substantial real borrowing costs that simply don't show up in reported interest expense until the asset is finished, sometimes a full decade later. Any interest coverage ratio calculated straight off the income statement should be treated as provisional for a company mid-construction on anything large. It's measuring against a borrowing cost the filing has quietly moved off the page.

Southern Company's Georgia Power subsidiary is close to a textbook case, because the Vogtle nuclear expansion ran long enough and cost enough that the capitalized-interest disclosure shows up clearly across a decade of 10-Ks. I'll walk through where the rule lives, what the Vogtle filings actually show, how to back the capitalized amount out of reported interest expense to get a truer coverage number, and what changes — not always for the better — once construction ends and the capitalization stops.

What ASC 835-20 Actually Requires

The rule is narrower than "capitalize interest whenever convenient." Not a blanket policy. It applies specifically to qualifying assets — those requiring a substantial period of time to get ready for their intended use — and only for the period construction is actually underway.

ASC 835-20, Capitalization of Interest: interest cost incurred during the construction period of a qualifying asset is capitalized as part of the asset's cost rather than expensed as incurred. Capitalization begins when expenditures have been made, construction activities are in progress, and interest cost is being incurred; it ends when the asset is substantially complete and ready for its intended use — regardless of whether it has actually been placed in service.

Utilities capitalize this cost under a related but distinct label: AFUDC, the Allowance for Funds Used During Construction. It's the regulated-utility version of the same idea, covering both the debt and equity components of financing a construction project, and it feeds into the rate base the utility is allowed to earn a return on once the asset goes into service. The mechanics differ slightly from ASC 835-20's general corporate version, but the effect on the income statement is the same: real financing cost, deferred out of the current period's interest expense line.

Georgia Power's Vogtle Reactors: A Decade of Deferred Financing Cost

The Early Estimate

Vogtle Units 3 and 4 — the first new nuclear reactors built in the United States in more than three decades — broke ground in 2009 with a projected in-service date of 2016 and 2017. Neither deadline held. By the time Georgia Power filed its Form 10-K for fiscal year 2017, the company was disclosing that its total financing costs for the project, to be capitalized through AFUDC, were expected to reach approximately $3.1 billion — of which roughly $1.6 billion had already been accrued through December 31, 2017. None of that $1.6 billion appeared as interest expense on Georgia Power's income statement in the years it accrued. All of it sat, instead, inside the growing construction-in-progress balance.

The Estimate Kept Growing

Construction delays compound financing costs the same way they compound everything else on a project this size. By the third quarter of 2022 — with the reactors still not in service — Southern Company's filings showed roughly $385 million of financing cost still expected to be capitalized through AFUDC, with $275 million of that already accrued as of September 30, 2022. Stack that on top of the 2017 figure and you get a sense of how much real borrowing cost a decade-plus construction timeline can push off the income statement before a single kilowatt-hour is sold.

Unit 3 finally entered commercial operation in July 2023. Unit 4 followed in April 2024. And that's where the capitalized-interest story reverses.

What Happens When Construction Ends

Southern Company's Form 10-K for fiscal year 2024 shows the mechanical flip. Interest expense, net of amounts capitalized, rose year over year — about $36 million of that from higher average outstanding borrowings and $30 million from higher rates on that debt, which is the ordinary story at almost any company. The filing also discloses a $31 million decrease in AFUDC debt specifically tied to Vogtle Units 3 and 4 — financing costs on a plant now in commercial service no longer qualify for capitalization. The interest didn't disappear. Just relocated — out of a construction-in-progress balance that never touched the income statement, and into ordinary interest expense the way any other debt's interest would appear.

How to Back Out Capitalized Interest From Reported Interest Expense

The fix, when you're evaluating a company financing a large multi-year project, is mechanical rather than complicated. The capitalized amount is disclosed — GAAP requires it, typically within the debt footnote or the supplemental cash flow disclosures — even though it isn't included in the interest expense line itself. Maintenance and growth capex split the same way total capex does: one figure sustains the business, the other funds an asset that isn't earning anything yet. Capitalized interest is the financing-cost equivalent, sitting quietly inside the capex a company is already spending on a project that hasn't started producing revenue.

Recomputed interest coverage, adjusted for capitalization: True Interest Incurred = Interest Expense (income statement) + Capitalized Interest (debt footnote or supplemental cash flow disclosure) Adjusted Interest Coverage = EBIT ÷ True Interest Incurred The adjusted figure will run lower than the reported ratio for any company mid-construction on a large qualifying asset — sometimes substantially lower — because it restores financing costs the income statement is, by design, not showing you yet.

The size of the adjustment depends entirely on where a company sits in its construction cycle, which is exactly why comparing two companies' reported coverage ratios at face value can mislead. Take two hypothetical regulated utilities, both reporting EBIT of $2 billion and reported interest expense of $400 million — an identical 5.0x coverage ratio on paper. Utility A finished its last major generation project three years ago and is capitalizing almost nothing today; its adjusted coverage stays close to 5.0x. Utility B is two years into a multi-billion-dollar plant build and is capitalizing $150 million of financing cost this year alone. Add that back and Utility B's true interest incurred rises to $550 million, dropping adjusted coverage to roughly 3.6x — a materially weaker number hiding behind an identical reported ratio. Nothing in either company's income statement flags which utility is actually carrying more current financing risk. The debt footnote does.

Why the Understatement Matters More Than a Rounding Error

A coverage ratio calculated without this adjustment isn't wrong in a GAAP sense — the company followed the rule correctly. It's an incomplete picture, though, of how much debt service the business is actually carrying right now — cash actually going out the door to lenders this year. Treating capitalized interest as though it weren't a real cost is the same mistake as treating a company's "adjusted" metrics as a fair substitute for the GAAP number underneath — technically defensible, and still missing the thing you were trying to measure. This matters most for capital-intensive regulated utilities, homebuilders financing land development, and any company mid-construction on a facility large enough to move the numbers. Smaller, routine capex rarely generates enough capitalized interest to distort coverage meaningfully.

Where the Distortion Doesn't Just Disappear

The understatement isn't temporary in the sense that it corrects itself cleanly. Once construction ends, capitalized interest converts into a permanently higher asset base, which means permanently higher depreciation for decades afterward. Free cash flow built from net income plus D&A minus capex will run through that elevated depreciation figure for the life of the asset, embedding the original financing decision into every year's reported numbers long after the reactors, or the plant, or the fleet, actually went into service. Yet the coverage-ratio distortion specifically — the part investors are most likely to misread in real time — is confined to the construction window itself. Read the two effects separately: one is a multi-decade depreciation legacy, the other is a multi-year understatement of current financing cost.

I'll admit the exact date a capitalization period closes is sometimes harder to pin down from the outside than the rule implies. "Substantially complete and ready for its intended use" is a judgment call management makes, and the filing tells you the AFUDC balance shifted — not the internal debate that produced that determination.

Key Takeaways

• ASC 835-20 requires capitalizing interest on qualifying assets during construction — a real, defensible accounting rule that still pushes true financing cost off the income statement until the asset is finished.
• Georgia Power's Vogtle disclosures show the scale this can reach: roughly $1.6 billion in accrued financing costs by the end of 2017, growing further before the reactors entered commercial service in 2023 and 2024.
• Add disclosed capitalized interest back to reported interest expense before trusting an interest coverage ratio for any company mid-construction on a large qualifying asset.
• The distortion doesn't vanish when construction ends — it converts into higher depreciation for the life of the asset, even after the interest-expense understatement itself resolves.