Home › CA Inter › Financial Management › Coverage Ratios › In computing Interest Coverage Ratio, the numera…
In computing Interest Coverage Ratio, the numerator uses EBIT (and not EAT) because:
AEBIT is always higher
BTax includes interest
CEAT is hard to calculate
DInterest is tax-deductible, so taxability does not affect ability to pay interest
Answer & Solution
Correct answer: D. Interest is tax-deductible, so taxability does not affect ability to pay interest
1. Interest is allowed as a tax-deductible expense.
2. Ability to pay interest is unaffected by tax burden, so EBIT is the right numerator.
3. Using EAT would understate the interest-paying capacity.
_Source: ICAI BoS CA Inter Paper 6A, Ch 3 "Financial Analysis and Planning — Ratio Analysis", §3.2.2(b)_