Hi all, i encounter a question on construction interest capitalization, for example the interest cost at total is 20, and after capitalizing it is depreciating at 5 each year, my post capitalization CFO is 220 and CFI is -100, I want to know what would the CFO and CFI be if I didnt capitalize the interest.
I understand for CFO you put back the 20, and the CFO adjust for capitalization would be 220-20, in the answer the CFI with adjustment is -100+20, is there an error here? I thouht the CFI should be -100+5 as the 5 is deducted from CFI after capitalization?
Remember that in event of adjusting CF in one category for certain amount you have to offset adjustment in another category for same amount with opposite prefix thus you have 0.00 total CF adjustment or there is no impact on final cash balance.
In your example you have to add back capitalized interest into CFO thus deduct CFO and offset same amount in CFI (+20).
The transaction described above is in clasiffication domain only, while firm exact spent this 20. For total cash balance doesn’t matter in which accounting category has this amount been classified
right , ok maybe i am just really confused with fundamentals, if depreciation is not cash flow, what do we mean when we say capitalized cost is accounted as CFI, i thought we mean depreciation is counted as CFI? so what is counted in CFI here?
Interest capitalization is BS and P/L category. When interest is expensed this exactly means that are charged to current year result while at capitalization the interest expense is capitalized to asset purchasing thus the expense through depreciation is brought forward to future periods partially.
Interest payment is a CF category. We should pay interest on borrowings no matter how we classified it. By GAAPs, if interest has been capitalized it should be classified into CFI, if interest has been expensed it should be CFO (or CFF as option by IFRS) category.
Although, it is maybe not asked in your example, there also may be different tax impact on CF depending how we classified an interest expense so tax adjustment between CF category should also be considered. However, the rule is the same, adjusting in one CF category should be offset in another, ending cash balance should remain unchanged.
ahh, i think i get it now, the capitalization and depreciation is just an accounting method, in actuality the interest is still paid, and if it is capitalized, the interest is paid as original amount in real life but is registered as CFI, and depreciation has nothing to do with cash flow? (here, do you remember the component of cash flow again to show how depreciation doesnt matter?)
I am unable to understand the impact of taxation on reclassification from CFI to CFO. Let’s take an example : for a hypothetical firm, if CFO is 100, Capitalized software development cost is 5 (classified in CFI), and tax rate is 30%, EBITDA is 15. Now, if we try to expense software development cost then new CFO won’t be 100-5 = 95 (which is what Curriculum has done) but CFO - ((EBITDA - Expense)*(1-tax)) = 100 - (15-5)*0.7 = 100-7 = 93. Correct?
I know that I am missing something here because the cash balance should remain the same, as you have mentioned in your post above. Could yourself or someone else please clarify this for me?
