EOC 2012, Reading 21, page 112, #8 Interest Coverage ratio - capitalized or expensed interests

CFA Level II
#1

Hi, I have not found the awnser on the forum.

The question is if capitalization of interests instead of expensing results in lower, higher or unchanged Interest Coverage Ratio …

The awnser according to CFAI is that IntCov rario is unchanged.

I hoped that the awnser is that it will be higher…

Maybe there is special context but I am not able to find it…

Anybody please could explain me why is unchanged.

#2

This is very interesting.

I know Interest expense is not the same under both method. to prove my point you can look at page 89 and see that you dont have interest cost under a operating lease.

looking at the answer, CFAi says that _ you have to adjust your interest expenditure and both the expensed portion and capitalized portion should be used _. so even if it’s not reported as a interest expense on the operating lease, you should adjust for it.

hope this help

#3

Look into solutions, they write that this ratio is based on interest payments not interest expenses, that’s why there is no changes. Formula 32 on page 4 - interest coverage=EBIT/Interest payments.

#4

Tricky!

#5

wouldn’t capitalising affect EBIT though? because of the depreciation? or do you adjust for that…

#6

even i have the same question as kiakaha , coz as far as i know capitalizing interest would change the EBIT but not the interest cost…coz in the years interest is capitalized its a allocated to Income statement thru deprecation and would also result in lower int exp which would increase the interest coverage ratio??? correct me if m wrong ?

#7

If we analyse payments, there is no change …but

The point is that we know this after look at the awnser … I will not see the awnser during the exam.

So the regular interest coverage is based on interests payments or expenses ?

#8

Interest payments

#9

i guess we have to adj EBIt for depreciation of interest.

#10

Is there a difference between an interest payment and an interest expense?

I assumed interest expense for a year would be the sum total of, interest payments made over the accounting time period?

#11

interest expense - this is what in Income Statement, interest payments - this is both from inc statement and capitalized on bs.