Reading 36 P. 352 I seem to have trouble to understand this. Can you help to break down the last sentence and make it more understandable? If interest capitalization has been large, the analyst must estimate the amortization. The amortization of capitalized interest is included in the depreciation expense. Thus, one can use the historical ratio of interest capitalized to total capital expenditures to estimate the portion of depreciation applicable to capitalized interest expense. What does it mean of the sentence after “Thus”??? Can you set a simple example by using numbers? Thx.
It’s saying to look at previous financial statements and compute the ratio of the amount of interest capitalized to total capital expenditures. In terms of a formula, it would look something like this: Amt of Interest Capitalized @ t-1 / Total Capital Expenditures @ t-1 The resulting fraction would then be multiplied against your total capital expenditures for the current period giving you the amount to amortized.
jdane416 Wrote: ------------------------------------------------------- > It’s saying to look at previous financial > statements and compute the ratio of the amount of > interest capitalized to total capital > expenditures. In terms of a formula, it would > look something like this: > > Amt of Interest Capitalized @ t-1 / Total Capital > Expenditures @ t-1 > > The resulting fraction would then be multiplied > against your total capital expenditures for the > current period giving you the amount to amortized. So this is the formula to calculate the amortization of the capitalized interest? So for example, we can use the 2007 historical ratio to calculate 2008 amortization of the capitalized interest, right? If considering the tax effect, should it be “Amt of Interest Capitalized @(1-t) / Total Capital Expenditures @(1-t)” instead of (t-1)? And if both numerator and denominator contain the factor (1-t), can it be ignored? Can any of you tell me where in our CFA textbooks have this formula? Many thanks.
there is no formula in the cfa book … and I also think that applying after tax factor to capital expenditure is not correct as it has nothing to do with tax. It should be, Hist cap interest / capex ; this ratio will tell you how much of the capex is interest cost. apply the above ratio to addition to assets and then apply the depreciation rate to the resulting amount. Example: Opening bal PPE = 15000, Depreciation SL @ 15% , Capex for the year 1000 including $100 for cap interest, tax rate 40%, Earnings for the year after tax before any adjustment is 5000. Hist cap interest / Capex = 100/1000 = 10% Addition to assets = 1000 => 10*1000 = 100 => 100*15% = 15 ----> amortization of capitalized interest. If you directly doing adjustment to after tax earnings then —> 5000 + 15*(0.6) - 100*0.6) = 4949 ----> adj earnings In the above example, we could have just let the amortization go as it is not material but it is just for illustration.
Thx, madanalyst. An example is always better than an arcane paragraph. Tried to digest your illustration and thought we ought to use two (consecutive???) accounting periods in order to show how to utilize the mentioned historical ratio. Assume previous acc. period Hist cap interest / capex = 10% Current acc. period capital expenditure = $1,500 --> Current estimated cap interest = 10% x $1,500 = $150 --> Current amortization of capitalized interest = $150 x 15% = $22.5 If the company decides to expense the interest, then the after tax adjusted earnings is: 5000 + 22.5*(0.6) - 150*(0.6) = $4,923.5 Two more questions here: 1) Why use SL depreciation rate to calculate the amortization? 2) Does “Earnings” here mean revenue/total sales or pretax income or EBITA? Are these terms interchangeable?
hyang: we only calculate the ratio for past periods because we have to estimate the amortization amount of cap interest … for current period the cap interest is given and we do not have to worry about amortization of current year about SL : just used it for sake of simplicity … other dep methods can be used By earnings I mean net income after tax … I dont know how you are using the revenue/total sales in context of earnings … but if would have meant EBITDA I will not doing tax adjustment … ( so working of the problem kind of explained it)
I see. So no such thing as “amortization of current year”… I was kind of asking silly questions. And Earnings = Net Income