In an answer in the long-lived asset section, CFAI states: “Capitalised interest appears on the balance sheet as part of the asset being constructed instead of being reported as interest expense in the period incurred. However, the interest coverage ratio should be based on interest payments, not interest expense (earnings before interest and taxes/interest payments), and should be unchanged. To provide a true picture of a company’s interest coverage, the entire amount of interest expenditure, both the capitalised portion and the expensed portion, should be used in calculating interest coverage ratios.” Then in the 2015 mock (AM), you are given a set asking youto make the adjustment to the intcov ratio for capitalized interest, you are provided with both interest expense and interest cash payments, and sure enough, the “correct” answer proceeds to use interest expense in the denominator. So which is the one to use?
OPERATING OR CAPITALIZING
NO CHANGE IN COVERAGE RATIO!
No this is wrong. If originally, interest coverage is based on payments in the denominator, maybe, in the specific case where you wouldn’t have to make adjustments to the denominator for the amortization of previously capitalized interest payments. But in most cases I would think expensing CI would have some impact on the ratio.
OK! you choose that there is a change on exam day! and I’ll choose that there is no change!!!
Its my understanding that when adjusting the interest coverage ratio for the effects of capitalized interest, you must adjust the numerator for the depreciation expense that was related to the capitalized interest (original EBIT + depreciation) and then you have the adjust the denominator for the amount of capitalized interest to get the true amount of interest paid (original interest expense + capitalized interest). Therefore there would be a difference in the ratios.
this depends on the _ definition _ of interest coverage ratio!!!
There will most likely be adjustments between the two I believe. Just as kos mentioned, those capitalized interest costs need to be converted to interest expense (the denominator). Additionaly, you’d need to adjust your EBIT (the numerator) to remove the depreciated capitalized interest portion.