Capitalizing Interest Costs understand, net, interest, increase, something

parott

How does capitalizing interest expense increase EBIT? I understand that capitalizing interest costs would increase net income by the amount of interest capitalized less the amount that is amortized in the year. However, since EBIT is obviously earnings BEFORE INTEREST and taxes wouldn’t capitalizing interest have no effect on EBIT? Or am I missing something here? This is related to problem #39 on the morning session of the mock exam.

RMontgomery

Wouldn't it decrease your EBIT? My thought process is, when you capitalize interest, you have to depreciate it along with the asset, leading to higher depreciation expense each period. This would lower your EBIT

maryli

In the period you capitalize, the P&L is not impacted.

You only Amortiza once the asset is ready

- Guille

jarobi04

good question. EBIT does not include interest expense,and so capitalizing it should instead increase NI in that period since no amortization has been passed to IS yet.

can someone explain why EBIT increas?

ayaz_mahmud369

You are allowed to cap. Interest on the balance sheet for an asset you are constructing (soft, real estate etc.) . Up to this point "relative to expensing" EBIT is higher

Once asset is complete, you need to depreciate/amortize on the income statement, which lower EBIT as the post capitalization expense is not recorded as interest expense (but as amortization of thr asset)

- Guille

kickthatcfa

@guille i get ya, however both EBIT under capitalizing or under expensing would initially be equal since interest expense does not impact the calculation of EBIT. i don't see how EBIT could be relatively higher or lower under either method in the initial time period....

WarrenB1

Project costs $100 million. If you get a loan for $100 million and you don't capitalize interest, your depreciation is $10 million (straight line, 10 years). EBIT= -$10 million.
If you calitalize interest, your asset is say $140 million, depreciation is $14 million. Your EBIT=-$14 million. EBIT under capitalized interest is lower.
No?

redskins44

yes you are correct, however from my understanding, the year that you capitalize is the current period, which is lets say time 0 for illustration, you would then incurr depreciation at time 1 and so on. but at time 0 you would incur no interest expense since the interest has been capitalized. i hope im making sense

giorgio10

What does the answer sheet say? This is a spoiler for me (taking the mock tomorrow)

- Guille

tikfed

they dont provide alot of explanation. all they say is that capitalizing the interest increased EBIT by a certain dollar amount. ive kept my explanation general, so as to not spoil it for you.