# Capitalising of Interest

Hi,

Can someone help me with this question? How did they get to \$188 and how is interest coverage is justified?

Q. A company’s debt covenant requires it to maintain an interest coverage of 2.25; the ratio is calculated using total interest paid. The following information is taken from the company’s 2014 financial statements:

2014 \$ thousands
Net sales 11,159
Cost of goods sold (COGS) 9,898
Selling and administrative expense (S&A) 872
Interest expense 122
Earnings before tax 267

Note 11: Property and Equipment (all figures in \$ thousands)

Depreciation expense for 2014 is \$388. This amount includes capitalized interest of \$34.

Interest is allocated and capitalized to construction in progress by applying the firm’s cost of borrowing rate to qualifying assets. Interest capitalized in 2014 is \$66.

Note 13: Long-Term Debt

All bonds were issued at par.

The most appropriate statement about the company’s debt covenant restriction in 2014 is that the firm:

1. just satisfied it.
2. failed to meet it by at least 5%.
3. exceeded it by at least 5%.

Solution: A is correct.

(\$ thousands)
EBIT = Net sales − COGS − S&A = 11,159 − 9,898 − 872 = 389
Add back depreciation related to capitalized interest 34