- CFA Exams
- CFA Level I Exam
- Study Session 8. Financial Reporting and Analysis (3)
- Reading 26. Long-lived Assets
- Subject 1. Capitalizing versus Expensing

###
**CFA Practice Question**

Which of the following statements is (are) true with respect to the impact that the capitalization of interest will have on certain financial ratios?

II. Accounting income will increase relative to cash flow.

III. Current ratio will increase.

IV. Asset turnover ratios will increase.

I. Interest coverage ratios will increase.

II. Accounting income will increase relative to cash flow.

III. Current ratio will increase.

IV. Asset turnover ratios will increase.

A. I and II

B. II and III only

C. I, III and IV

**Explanation:**Statement III is not correct because capitalized interest will be a part of long term assets rather than current assets.

Statement IV is not correct because capitalized interest will inflate asset values, causing the asset turnover ratio to drop.

###
**User Contributed Comments**
10

User |
Comment |
---|---|

todolist |
capitalization if interest is long term debt, not part of current ratio |

teje |
capitalization of interest results in higher noncurrent asset values, and therefore does not affect the current ratio. |

poomie83 |
interest coverage = EBIT/interest expense Capitalising interest will lead to higher int coverage |

jasonkwk |
capitalized interest --->investing cashoutflows expensed interest ---> operating cash outflows |

birdperson |
on the current ratio -- wouldn't the capitalized interest result in lower current liabilities than if the interest had been expensed? |

birdperson |
so therefore current ratio (current assets / current liabilities) increases because CL drops? |

daverco |
Based on the curriculum, capitalizing interest should not alter the interest coverage ratio. Whether capitalized or not, all interest payments should be captured in the interest coverage ratio to gauge solvency. Check EOC problem 8 in reading Long-Lived Assets. |

standaert |
@daverco: the textbook says it should be "interest paid", not "interest expense", but in reality the interest coverage ratio is EBIT/interest expense. Search online ... When capitalizing interest expense it gets smaller and so the ratio increases. |

rjdelong |
Standaert's comment seems right: if you capitalize the interest you don't expense it, so the expense drops and the ratio will increase |

Patdotcom |
if you capitalize interest, inventory increase and current ratio should increase too, am I wrong? Re interest coverage ratio, I had the same understanding as daverco.. What s the difference between interest expense and interest paid? |