Why is it that cash expenditures for capitalized assets never flow through CFO. Is there any logic behind that or is it simply a rule
If the asset is capitalized, then it will increase LT assets, in which case it is CFI
so is it safe to assume there is no interest expense??? Or is this interest expense also classified as CFi
If the interest is capitalized I believe that it will not go through CFO. However interest can be capitalized only if you incur it during the process of getting the asset ready for operation. Interest incurred during purchase of an asset cannot be capitalized.
> so is it safe to assume there is no interest expense??? Or is this interest expense also classified as CFi A capital expenditure is a purchase that will reduce CFI. It ends up as an asset that will be offset by accumulated depreciation over time. If there is capitalized interest associated (construction for example), then that becomes a matter of accounting policy on a firm by firm basis - I just checked with my company’s accounting group. They said it could go through depreciation expense, interest expense (prepaid interest for example), or potentially some other way. Since precise treatment appears to be at the discretion of management, it’s probably safe to say that you would be given a little more direction on where the interest is flowing in an actual problem. That said, I remember doing some practice problems in the CFAI texts on interest capitalization and related amortization. In fact, I think I’ll stick that on my stuff-to-review sheet.
Great explanation! thanks
I’m pretty sure that the interest component of a capitalised lease payment does indeed come from CFO. If I’m wrong can someone correct me? Thanks, Andrew
This thread is in reference to capitalization vs expensing on assets. Capital leases vs operating leases is a whole other cup of tea
That’s correct: interest component of a capitalized lease payment comes out of CFO. For an operating lease, the entire payment comes from CFO. For a capital lease, interest comes from CFO and principal amortization comes from CFF. The question of what happens to the interest coverage ratio with a capital lease is confusing because the numerator and denominator both increase. I find that CFA likes asking questions where the numerator and denominator change in the same direction. To answer, one needs to reflect on whether the numerator or denominator is likely greater, prior to the adjustment. Since EBIT should be larger than interest expense for a healthy firm (the test would have to state if this was a special case where EBIT is less than interest expense), an increase of the numerator and the denominator by the same amount will decrease the coverage ratio. For example, 50/10 is 5, but 60/20 is 3.
when you capitalize the interest expense that comes with building an asset, it is deducted from total interest expense because it is already accounted for in CFI. So, capitalized interest will have an affect on CFO, it will increase CFO. Tread carefully in this thread, there is some misinformation goin on in here.