The capitalization of interest associated with self-constructed assets was discussed in this chapter. A recent annual report for WestJet Airlines disclosed the following information concerning capitalization of interest:
Significant accounting policies (continued):
Capitalized interest costs:
Costs associated with assets under development, which have probable future economic benefit, can be clearly defined and measured, and are incurred for the development of new products or technologies, are capitalized. These costs are not amortized until the asset is substantially complete and ready for its intended use, at which time they are amortized over the life of the underlying asset. Interest attributable to funds used to finance property and equipment is capitalized to the related asset until the point of commercial use. Costs of new route development are expensed as incurred.
Assume that WestJet capitalized interest in the amount of \(\$ 500,000\) and disclosed \(\$ 2.2\) million of interest expense in its income statement for the year. One useful accounting ratio is the interest coverage ratio (Profit before interest and taxes divided by Interest expense).
Required:
1. Explain why an analyst would calculate this ratio.
2. Did WestJet include the \(\$ 500,000\) in the reported interest expense of \(\$ 2.2\) million? If not, should an analyst include it when calculating the interest coverage ratio? Explain.