One objective of financial statements is to provide information about cash flows

Question

One objective of financial statements is to provide information about cash flows. However, one criticism of interest capitalization is that this process may artificially create a difference between earnings and cash flows. Which of the following is true?

A. Interest capitalization does not induce a difference between earnings and cash flows since interest expense is a close approximation to the cash paid for interest.

B. Interest capitalization causes interest expense to differ from cash paid for interest by a greater amount than would otherwise be true.

C. Interest capitalization is an accrual accounting method, so there is no effect on the presentation of cash flows.

D. Interest capitalization induces differences between earnings and cash flows because it is treated differently for tax accounting and financial reporting purposes.

Explanation / Answer

B. Interest capitalization causes interest expense to differ from cash paid for interest by a greater amount than would otherwise be true.

Explanation:

Interest capitalisation means to capitalise the amount on interest to the cost of the asset , instead of deducting it from income statement. so, it got deducted in the form of depreciation over a period of time. hence there will be differnce between the cash paid for interest expense and actual interest expense.

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