The example below is stated below incl the solution:
My question: Why isn’t the $34 capitalized interest included firs in depreciation also added to the interest expense like the $66 newly capitalized interest is? Is it because this interest is NOT actually paid this period like the new $66 Capit. int is?
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 $66.
Note 13: Long-Term Debt
All bonds were issued at par.
The most appropriate statement about the company’s debt covenant restriction in 2014 is that the firm:
- just satisfied it.
- failed to meet it by at least 5%.
- exceeded it by at least 5%.
Solution
A is correct.
($ thousands) EBIT = Net sales − COGS − S&A = 11,159 − 9,898 − 872 = 389 Add back depreciation related to capitalized interest 34 Adjusted EBIT 423 Interest expense: Income statement 122 Add capitalized interest: Notes to financial statement 66 Total interest paid
188
