I was wondering if you could help with this question from Schweiser: Capitalising Construction Interest Costs leads to: a) Lower debt ratio b) Higher future depreciation expense c) Lower reported income after the first year d) All of the above The answer is d) but I don’t understand why. I thought option C) is wrong you would have higher net income after the first year because you are capitalising interest and not expensing it all at once?
Doesn’t capitalising costs lead to higher NI in current period and lower in future periods?
All are correct, so the answer is D. Capitalizing interest means that interest cost is added to the asset and to the liability (over the life of the asset, the asset is depreciated while the liability is accreted). A) D/E is lower because Liability (i.e. debt is higher), making the numerator bigger and the whole fraction bigger B) Higher Future Depreciation expense - true because since you have added the interest, it has to be depreciated over the life of the asset, meaning there will be more depreciation expense in future years C) Lower reported NI after first year – true. Same idea as B. Because you’ve added the interest, you’re also going to be faced with higher depreciation each year, so after the first year, your net income is reduced due to depreciation. The key is that it says AFTER the first year. In the first year, your NI under expensing will be lower because you’ve included the entire expense right away. But after year 1, that expense has been taken care of, but you are still depreciating under capitalization. Hope that helps.
Ah yes I missed the part about after Thanks
Agrees with Chad