CFA Practice Question

There are 520 practice questions for this study session.

CFA Practice Question

Reclassification of capitalized interest as an expense will have the following balance sheet effect:
A. Reduction in shareholders' equity by the product of the change in capitalized interest and (1 - Tax rate).
B. Decrease in deferred tax liability by the change in capitalized interest.
C. Reduction in capitalized asset by the product of (1 - Tax rate) and capitalized interest adjustment.
Explanation: By treating capitalized interest as an expense, net income will be reduced by the amount of capitalized interest, with a tax saving of the capitalized interest multiplied by the tax rate. The net is given by:

Reduction in shareholders' equity = (1 - Tax rate) x Capitalized interest

User Contributed Comments 7

User Comment
danlan Why C is wrong?
eddeb Because interest included in the initial capitalization is being written off annually with depreciation..
Tobi3 C is wrong because there is no income tax effect on the reduction of capitalized asset. Only when the reclassified interest expense hits income statement when there is income tax effect. This interest expense, net of tax, then hits equity.
teje just as an aside, a reduction in an asset, say from an impairment would result in a loss, which than would have an effect on income tax.
olympria Yes teje, but it will not reduce the ASSET by the tax amount. Option C says "Reduction in Capitalised ASSET by..." The Asset will only be reduced by the interest amount which is now being removed from it to be expensed. And then separately, the CF will be affected by that tax amount. But both together (i.e., Expensed Interest and the tax on Interest) will affect Income Statement (which will then eventually affect Shareholder's equity).
rjdelong olympria's answer is the clearest
dbedford A - L = OE

A - increased L by the recognized expense = lower OE
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