long lived assets

CFA Level II
#1

Hi,

I am wondering why the depreciation from previous year’s capitalization of interest costs are added instead of subtracted from EBIT.

Reading 21, Example 3.

$475 depreciation is added to EBIT to calculate the interest coverage ratio.When the depreciation is present, EBIT should be reduced. Can’t understand this.

Thanks for your help.

#2

If the Capitalization had not happened - depreciation would have been 475 less?

So you actual EBIT would have been 475 higher

and Interest expense would have been higher as well…

So true Int Cov Ratio = EBIT / Int --> will now be properly reflected after making the above adjustments. This will also make two companies one that capitalized interest vs. another one that did not - now comparable.

#3

Thanks CP. I misunderstood the question.

From the answer, " …including an adjustment to EBIT for depreciation of previously capitalised interest", I misinterpreted it as with capitalization.