Capitalized interest and EBIT interest, 2010, affect, amount

luckygiftvn

How does capitalizing interest affect EBIT?

From my understanding,

1. If interest is expensed, it is expensed under EBIT.
2. If interest is capitalized, it is added to PP&E. This increases depreciation.

Therefore, if we capitalize interest, EBIT should be lower due to more depreciation.

But from 2010 CFAI sample exam Q15
It says "the capitalization of interest costs increased EBIT by 30 million (the amount of total interest capitalized".

Since interest is normally expensed under EBIT, I don't see why capitalized interest should be added to EBIT when we adjust the income statement.

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PS. For software development cost and other capitalized costs, I understand that if we choose to expense, they will be expensed above EBIT. Therefore, if we capitalize, EBIT should increase by the amount. Do I understand this correctly?

cv4cfa

"it will show on balance sheet as interest (30mil) and deducted from EBIT, when it is capitalised, the interest would be (0mil) and nothing would be deducted off EBIT."

You mean it will show on income statement, I presume.

And why should EBIT change?
When interest is expensed, it is deducted from EBIT, therefore EBT is affected, not EBIT.
Capitalized interest should not be added back to EBIT.


"When interest is capitalised EBIT is higher"

On CFAI book 2 page 64 solution to 1, EBIT is higher if interest is expensed.



Edited 1 time(s). Last edit at Sunday, May 15, 2011 at 08:52AM by zestzorb.

ayaz_mahmud369

oh, yeh, I was thinking EBT, listen to someone else.

Houjichasan

The question asks "Which accounting policies had the largest effect on the increase in EBIT?" (The vignette capitalized software costs and interest costs.)

Since capitalizing interest costs should decrease EBIT, I think the correct answer should be
B. Software costs
because if expensed, software cost is above EBIT. Therefore EBIT is higher when capitalizing than when expensing software costs.



Edited 1 time(s). Last edit at Sunday, May 15, 2011 at 09:59AM by zestzorb.

giorgio10

I don't think capitalizing interest costs always decreases EBIT- in fact like here it probably usually increases it. Think capitalizing vs. expensing and the effects on earnings...if you capitalize something your earnings are higher.

defour44

Your earning (net income) are higher because you don't expense your interest.
However in this case, EBIT isn't affected by interest expense. That's why I don't see how EBIT could increase by capitalizing interests.

comp_sci_kid

oh right, well i think that's the general idea....capitalizing increases earnings....maybe it's technically wrong though