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.作者: RMontgomery 时间: 2011-7-13 14:49
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作者: maryli 时间: 2011-7-13 14:49
In the period you capitalize, the P&L is not impacted.
You only Amortiza once the asset is ready
- Guille作者: jarobi04 时间: 2011-7-13 14:49
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?作者: ayaz_mahmud369 时间: 2011-7-13 14:49
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作者: kickthatcfa 时间: 2011-7-13 14:49
@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....作者: WarrenB1 时间: 2011-7-13 14:49
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?作者: redskins44 时间: 2011-7-13 14:49
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作者: giorgio10 时间: 2011-7-13 14:49
What does the answer sheet say? This is a spoiler for me (taking the mock tomorrow)
- Guille作者: tikfed 时间: 2011-7-13 14:49
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.作者: tarunajwani 时间: 2011-7-13 14:49
The only thing i can think of is that it is the full amount of the capitalization vs. Expensing it in that given year
But yes again as you say, even so it affects the interest expense line.
That's it im not sleeping tonight
- Guille作者: Uranus08 时间: 2011-7-13 14:49
Has to be errata, has to be
- Guille作者: sameeragarwal 时间: 2011-7-13 14:49
Agreed. EBIT is the same at time 0 and would be lower by depreciation amount (interest portion) in following periods.作者: defour44 时间: 2011-7-13 14:49
I figured out how they screwed up the answer key. The correct answer is absolutely C.
The reason why the answer key is wrong is because they mislabeled the figures in the original question and the answer key person got confused. Follow me here:
If you look at the Income Statement all values are denoted in thousands.
This means 3,510 in reported expenses is 3 million, 510k in expenses.
Now go to the footnotes.
The footnotes say Interest Costs (in *MILLIONS*)
What CFA is NOW saying here is now that the interest expense is 3 billion 510 million a year. It makes 0 sense. How does a company doing 1.1 B in revenues have 3.5 billion in interest costs. Whatever, let's go with it 30 K in capitalized interest expenses is now a huge 30 million.
Then you go to the answer key and what should have been the $4.0 M in software capitalization expense being greater than the 30,000 in interest cost is now LESS than the 30 million in interest costs, so they picked interest costs as the answer.
If they had properly labeled the figures, it would have come out to software development capitalization increasing EBIT the most, not interest costs.
I sat for 5 mins looking at these figures going.. WTF... ??? wtf ??? how are they booking 3.5 billion in interest costs on a $1.1 B topline business. these guys are Enron^2.
