Capitalizing construction interest lead to:

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neagu.alexandru

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Capitalizing construction interest lead to:

A. Lower debt ratio
B. Higher future depreciation expense
C. Lower reported income after the first year
D. All of the above

What do you think?
 
1. Increases assets. So lower Debt ratio.
2. Because assets go up, current and future depreciation expense will be higher
3. Higher depreciation will lower the reported income.

So choice D.

realize that given "All of the above" choice above, this would not be a question that would appear on the real exam.

CP
 
Thanks you for the prompt answer. But I have just one question. When you calculate net income dont't you say:

net income year end= net income begining + cash operating expense(that were capitalize)-depreciation

and if cash operating expense is greater than depreciation than net income is greater
 
Wouldn't expensing result in the worst first year reported income?
A+B?
 
First time post, lets see if I can help.

Neagu,

If at the end of the accounting period, you realize you have expensed something that should have been capitalized, you will have to increase both Net Income and Assets to correct for the mistake. Both NI and Assets will increase by the amount of the capitalized expense.

Depreciation expense will increase, reflecting the depreciation from the new capitalized expense.

Since the depreciation of the capitalized expense will be spread out over time, the depreciation expense will be only a fraction of the total each year.

So although depreciation will increase, it increases by less than the reduction of total expense, meaning capitalizing will ALWAYS result in higher net income for the current period.

Dan Lieb,

Capitalizing the expense will spread out its effect over a few years.
Regular expensing is incurred all in one period.
So yes, expensing will result in the lower current period income than capitalizing.

Hope that helped!
MDD
 
Sorry, that should read:

So although depreciation will increase, it increases by less than the reduction of *INTEREST* expense, meaning capitalizing will ALWAYS result in higher net income for the current period.
 
chasinggoats that is what I said in other words, so net income will be greater. So what is the correct answer to the question?
 
Lower reported income after the first year --> it says after first year. After the first year - higher depreciation expense leads to lower income.

we agreed on a and b as being right. Given the only other choices are c and d which was all of the above - by reasoning it HAS to be D) all of the above.

That is the only answer for this question.
 
cpk can you please respond to my question?

When you calculate net income dont't you say:

net income year end= net income begining + cash operating expense(that were capitalize)-depreciation

and if cash operating expense is greater than depreciation that results in greater net income

so C is not a good answer
 
You are confusing between the first year and what happens in later years.

Year 1: You increased the Assets -- so your total assets went up. First year, there is no impact on Net Income.

From the next year onwards -- you are taking a bigger depreciation expense, hence AFTER THE FIRST YEAR (WHICH MEANS IN LATER YEARS) you have a LOWER NET INCOME, provided your revenues remain the same.


and your C choice was:
C. Lower reported income <B>after the first year </B>

CP
 
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