# Category Long-Lived Assets- Debt covenant

Hi guys, please help me with this question. Im not really understand why they add capitalized interest (Notes to financial statement) to interest expense. Thank you.

Question:

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 = Sales – COGS – S&A = 11,159 – 9,898 – 872 = 389
Add back depreciation related to capitalized interest 34