Reading 17 - Practice Question 8 (P.103)

[Jack Kwan]

Hi Everyone
Why is the answer not B but C?
There is no interest expesne but depreciation when the interest is capitalized instead of expensed. Interest coverage ratio should be higher?
Thanks

 

[JayWill]

The answer is stated right in the solutions. When calculating interest coverage ratios, the total interest expenditure, both capitalized and expensed should be used, since interest still has to be paid no matter how accounting decisions treat it. Thus the decision to capitalize interest costs has no effect on the interest coverage ratio.

 

[Jack Kwan]

JayWill wrote:
The answer is stated right in the solutions. When calculating interest coverage ratios, the total interest expenditure, both capitalized and expensed should be used, since interest still has to be paid no matter how accounting decisions treat it. Thus the decision to capitalize interest costs has no effect on the interest coverage ratio.

Thank you JayWill.
However, according Schweser Book 2 P.27,
There is a description about interest coverage ratio.
“In the year of the expenditure, capitalizing results lower interest expense and higher net income compared to expensing. The result is a higher interest coverage ratio (smaller denominator) when interest is capitalized.”
Confusing….
Thanks