CFA Level 1 Exam: False Statements about Interest Expenses and Capitalization

False Statements about Interest Expenses and Capitalization

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Question

Which of the following is/are FALSE?

I. Interest expenses that are capitalized are charged against investing cash flows.

II. Firms that expense interest costs incurred on debt must treat them as financing cash flows.

III. Firms that expense costs show lower equity than comparable firms that capitalize the costs.

IV. Capitalization of expenses leads to lower tax payments in the first year.

Answers

Explanations

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A. B. C. D.

B

Interest expenses are treated as operating cash flows under US GAAP. Capitalization leads to higher net income since the entire expenses are not charged against it. Due to this, the tax deductions are lower in the first year, leading to higher taxes. The higher income leads to the capitalizing firm having a higher equity.

The difference in equity reduces over time to zero.

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