Making a Decision as a Financial Analyst: Interpreting the Impact of the Capitalization of Interest on an Accounting Ratio
Hess Corporation is a global energy company that explores, produces, refines, and markets crude oil and natural gas. The capitalization of interest associated with self-constructed assets was discussed in this chapter. A recent annual report for Hess Corporation disclosed the following information concerning capitalization of interest:
In Note 1:
Capitalized Interest: Interest from external borrowings is capitalized on material projects using the weighted average cost of outstanding borrowings until the project is substantially complete and ready for its intended use, which for oil and gas assets is at first production from the field. |
In Note 7:
The Corporation capitalized interest of $7 million, $50 million, and $100 million in 2008, 2007, and 2006, respectively. |
The company reported $267 million in Interest Expense on the 2008 income statement. A popular accounting ratio used by some analysis is the interest coverage ratio (Income ÷ Interest Expense).
Required:
1. Explain why an analyst would calculate the interest coverage ratio.
2. Did Hess include the $7 million capitalized interest in the reported interest expense of $267 million? If not, should an analyst include it when calculating the interest coverage ratio? Explain.
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