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:

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 = 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

the \$34 depreciation of cap. interests refer to cap. interests of the past , which are amortized over time. The “real” interests for the period are only the expensed interests of \$122 plus the capitalized interests in this period of \$66. Regards, Oscar

Thanks again Oscar

Hello, I have a question why rest of the depreciation (\$388-\$34) was not considered in EBIT calculation?