CFA Practice Question

There are 520 practice questions for this study session.

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?

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?
You need to log in first to add your comment.