Capitalizing interest or expensing interest and how it impacts the Interest Coverage Ratio
Apparently interest coverage ratio should remain unchanged (whether capitalizing interest or expensing it when incurred) because the interest coverage ratio should be based on interest payments and non interest expense (at least according to the solution to a practice problem number 30 CFAI on 29 Long Lived Assets)
but my question is, won’t the interest coverage ratio be smaller for capitalized interest? Here is my logic behind it.
So lets say interest coverage ratio = EBIT/(interest payments)
Well okay lets assume that to be true, meaning the denominator (interest payments) remains unchanged.
But regardless, won’t the EBIT (numerator) change? Won’t capitalizing interest decrease EBIT, as the " interest expense" is now categorized either as depreciation expense (if related assets is held for use) or COGS (if related assets held for sale)?
When interest was expensed, it didn’t affect EBIT at all because EBIT is after all earnings BEFORE interest (and taxes) right? but now since it isn’t “interest” but some other expense (depreciation or COGs which affects operating income calculations), won’t the EBIT decrease?
Thus won’t the interest coverage ratio be smaller for capitalized interest? I feel lost and feel like I am missing a key point here, but I don’t know what!! Thanks!!
