LONG LIVED ASSETS

Jordan’s response about the ratio impact of Alpha’s decision to capitalise interest
costs is most likely correct with respect to the:
A interest coverage ratio.
B fixed asset turnover ratio.
C interest coverage and fixed asset turnover ratios.

Doubt – Capitalized interest will surely impact the asset’s carrying value. On the other hand it should also impact the interest coverage ratio.

CFA Book Explanation for this question –
B is correct. Alpha’s fixed asset turnover will be lower because the capitalised
interest will appear on the balance sheet as part of the asset being constructed.
Therefore, fixed assets will be higher and the fixed asset turnover ratio (total
revenue/average net fixed assets) will be lower than if it had expensed these
costs. Capitalised interest appears on the balance sheet as part of the asset
being constructed instead of being reported as interest expense in the period
incurred. However, the interest coverage ratio should be based on interest
payments, not interest expense (earnings before interest and taxes/interest
payments), and should be unchanged. To provide a true picture of a company’s
interest coverage, the entire amount of interest expenditure, both the capitalised
portion and the expensed portion, should be used in calculating interest
coverage ratios.