{"id":4152,"date":"2020-10-26T16:37:00","date_gmt":"2020-10-26T16:37:00","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/wm-financialaccounting\/?post_type=chapter&#038;p=4152"},"modified":"2020-11-16T17:16:50","modified_gmt":"2020-11-16T17:16:50","slug":"times-interest-earned","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/chapter\/times-interest-earned\/","title":{"raw":"Times Interest Earned","rendered":"Times Interest Earned"},"content":{"raw":"<div class=\"textbox learning-objectives\">\r\n<h3>Learning Outcomes<\/h3>\r\n<ul>\r\n \t<li style=\"font-weight: 400;\">Calculate the times interest earned ratio<\/li>\r\n<\/ul>\r\n<\/div>\r\nThe final \u201cgearing\u201d or \u201cleverage\u201d ratio is commonly called <strong>times interest earned<\/strong>.\r\n\r\n[latex]\\dfrac{\\text{net income before tax}+\\text{interest expense}}{\\text{interest expense}}[\/latex]\r\n<table class=\"fin-table acctstatement\"><caption>Jonick Company\r\nComparative Income Statement\r\nFor the Years Ended December 31, 2019 and 2018<\/caption>\r\n<tbody>\r\n<tr>\r\n<th class=\"u-sr-only\" scope=\"col\">Description<\/th>\r\n<th scope=\"col\">2019<\/th>\r\n<\/tr>\r\n<tr>\r\n<td colspan=\"2\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Other revenue and expenses<\/strong><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 \u00a0 \u00a0 Gain on sale of investments<\/td>\r\n<td class=\"r\">$137,000<\/td>\r\n<\/tr>\r\n<tr class=\"highlight\">\r\n<td>\u00a0 \u00a0 \u00a0 Interest expense<\/td>\r\n<td class=\"r\">(55,000)<\/td>\r\n<\/tr>\r\n<tr aria-hidden=\"true\">\r\n<td><\/td>\r\n<td class=\"line-single\" colspan=\"1\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<\/tr>\r\n<tr class=\"highlight\">\r\n<td>Income before income tax<\/td>\r\n<td class=\"r\">$314,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Income tax expense<\/td>\r\n<td class=\"r\">66,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td><strong>Net income<\/strong><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$248,000 <span class=\"u-sr-only\">Double Line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nFor Jonick, net income before tax (NIBT) +\u00a0interest expense is $314,000 + $55,000 = $369,000. That represents the amount of accrual basis income available to pay interest and taxes and to provide a profit for the business (and by extension, the owners).\r\n\r\nSince interest expense had been deducted in arriving at income before income tax on the income statement, it is added back in the calculation of the ratio.\r\n\r\nDividing that amount by the amount of interest expense gives a factor that indicates how much income is available to pay interest on borrowed funds. Let's do the calculations:\r\n<p style=\"padding-left: 30px;\">[latex]\\dfrac{\\$314,000+\\$55,000}{\\$55,000}=\\dfrac{369,000}{55,000}=6.7090909\u2026\\approx6.71[\/latex]<\/p>\r\nIn other words, Jonick, in 2019, earned, before taxes, 6.7 times the amount of interest incurred.\r\n\r\nThe number of times anything is earned is always more favorable when it is higher since it impacts the margin of safety and the ability to pay as earnings fluctuate, particularly if they decline.\r\n\r\nAs with all these metrics, as an investor or owner, or manager, you could devise variations. For instance, a similar ratio could be applied to preferred dividends by dividing net income by preferred dividends in order to monitor the company\u2019s ability to pay those dividends.\r\n<p style=\"padding-left: 30px;\">[latex]\\dfrac{\\text{net income}}{\\text{preferred dividends}}[\/latex]<\/p>\r\n<p style=\"padding-left: 30px;\">For example:\u00a0[latex]\\dfrac{248,000}{12,000}=20.7[\/latex]<\/p>\r\n\r\n<div class=\"table-wrapper\">\r\n<table class=\"fin-table acctstatement\"><caption>Jonick Company\r\nComparative Income Statement\r\nFor the Years Ended December 31, 2019 and 2018<\/caption>\r\n<tbody>\r\n<tr>\r\n<th class=\"u-sr-only\" scope=\"col\">Description<\/th>\r\n<th scope=\"col\">2019<\/th>\r\n<\/tr>\r\n<tr>\r\n<td>Income before income tax<\/td>\r\n<td class=\"r\">$314,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Income tax expense<\/td>\r\n<td class=\"r\">66,000<\/td>\r\n<\/tr>\r\n<tr class=\"highlight\">\r\n<td><strong>Net income<\/strong><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$248,000 <span class=\"u-sr-only\">Double Line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<table class=\"fin-table acctstatement\"><caption>Jonick Company\r\nComparative Retained Earnings Statement\r\nFor the Years Ended December 31, 2019 and 2018<\/caption>\r\n<tbody>\r\n<tr>\r\n<th class=\"u-sr-only\" scope=\"col\">Description<\/th>\r\n<th scope=\"col\">2019<\/th>\r\n<\/tr>\r\n<tr>\r\n<td>Retained earnings, beginning of year<\/td>\r\n<td class=\"r\">$2,198,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Net income<\/td>\r\n<td class=\"r\">248,000<\/td>\r\n<\/tr>\r\n<tr class=\"highlight\">\r\n<td>Less: Preferred stock dividends<\/td>\r\n<td class=\"r\">12,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 \u00a0 \u00a0 Common stock dividends<\/td>\r\n<td class=\"r\">8,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Increase in retained earnings<\/td>\r\n<td class=\"r line-single\">20,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Gross Profit<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$2,426,000<span class=\"u-sr-only\">Double Line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n<div class=\"textbox tryit\">\r\n<h3>PRACTICE QUESTION<\/h3>\r\nhttps:\/\/assessments.lumenlearning.com\/assessments\/23872\r\n\r\n<\/div>","rendered":"<div class=\"textbox learning-objectives\">\n<h3>Learning Outcomes<\/h3>\n<ul>\n<li style=\"font-weight: 400;\">Calculate the times interest earned ratio<\/li>\n<\/ul>\n<\/div>\n<p>The final \u201cgearing\u201d or \u201cleverage\u201d ratio is commonly called <strong>times interest earned<\/strong>.<\/p>\n<p>[latex]\\dfrac{\\text{net income before tax}+\\text{interest expense}}{\\text{interest expense}}[\/latex]<\/p>\n<table class=\"fin-table acctstatement\">\n<caption>Jonick Company<br \/>\nComparative Income Statement<br \/>\nFor the Years Ended December 31, 2019 and 2018<\/caption>\n<tbody>\n<tr>\n<th class=\"u-sr-only\" scope=\"col\">Description<\/th>\n<th scope=\"col\">2019<\/th>\n<\/tr>\n<tr>\n<td colspan=\"2\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Other revenue and expenses<\/strong><\/td>\n<\/tr>\n<tr>\n<td>\u00a0 \u00a0 \u00a0 Gain on sale of investments<\/td>\n<td class=\"r\">$137,000<\/td>\n<\/tr>\n<tr class=\"highlight\">\n<td>\u00a0 \u00a0 \u00a0 Interest expense<\/td>\n<td class=\"r\">(55,000)<\/td>\n<\/tr>\n<tr aria-hidden=\"true\">\n<td><\/td>\n<td class=\"line-single\" colspan=\"1\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<\/tr>\n<tr class=\"highlight\">\n<td>Income before income tax<\/td>\n<td class=\"r\">$314,000<\/td>\n<\/tr>\n<tr>\n<td>Income tax expense<\/td>\n<td class=\"r\">66,000<\/td>\n<\/tr>\n<tr>\n<td><strong>Net income<\/strong><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$248,000 <span class=\"u-sr-only\">Double Line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>For Jonick, net income before tax (NIBT) +\u00a0interest expense is $314,000 + $55,000 = $369,000. That represents the amount of accrual basis income available to pay interest and taxes and to provide a profit for the business (and by extension, the owners).<\/p>\n<p>Since interest expense had been deducted in arriving at income before income tax on the income statement, it is added back in the calculation of the ratio.<\/p>\n<p>Dividing that amount by the amount of interest expense gives a factor that indicates how much income is available to pay interest on borrowed funds. Let&#8217;s do the calculations:<\/p>\n<p style=\"padding-left: 30px;\">[latex]\\dfrac{\\$314,000+\\$55,000}{\\$55,000}=\\dfrac{369,000}{55,000}=6.7090909\u2026\\approx6.71[\/latex]<\/p>\n<p>In other words, Jonick, in 2019, earned, before taxes, 6.7 times the amount of interest incurred.<\/p>\n<p>The number of times anything is earned is always more favorable when it is higher since it impacts the margin of safety and the ability to pay as earnings fluctuate, particularly if they decline.<\/p>\n<p>As with all these metrics, as an investor or owner, or manager, you could devise variations. For instance, a similar ratio could be applied to preferred dividends by dividing net income by preferred dividends in order to monitor the company\u2019s ability to pay those dividends.<\/p>\n<p style=\"padding-left: 30px;\">[latex]\\dfrac{\\text{net income}}{\\text{preferred dividends}}[\/latex]<\/p>\n<p style=\"padding-left: 30px;\">For example:\u00a0[latex]\\dfrac{248,000}{12,000}=20.7[\/latex]<\/p>\n<div class=\"table-wrapper\">\n<table class=\"fin-table acctstatement\">\n<caption>Jonick Company<br \/>\nComparative Income Statement<br \/>\nFor the Years Ended December 31, 2019 and 2018<\/caption>\n<tbody>\n<tr>\n<th class=\"u-sr-only\" scope=\"col\">Description<\/th>\n<th scope=\"col\">2019<\/th>\n<\/tr>\n<tr>\n<td>Income before income tax<\/td>\n<td class=\"r\">$314,000<\/td>\n<\/tr>\n<tr>\n<td>Income tax expense<\/td>\n<td class=\"r\">66,000<\/td>\n<\/tr>\n<tr class=\"highlight\">\n<td><strong>Net income<\/strong><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$248,000 <span class=\"u-sr-only\">Double Line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<table class=\"fin-table acctstatement\">\n<caption>Jonick Company<br \/>\nComparative Retained Earnings Statement<br \/>\nFor the Years Ended December 31, 2019 and 2018<\/caption>\n<tbody>\n<tr>\n<th class=\"u-sr-only\" scope=\"col\">Description<\/th>\n<th scope=\"col\">2019<\/th>\n<\/tr>\n<tr>\n<td>Retained earnings, beginning of year<\/td>\n<td class=\"r\">$2,198,000<\/td>\n<\/tr>\n<tr>\n<td>Net income<\/td>\n<td class=\"r\">248,000<\/td>\n<\/tr>\n<tr class=\"highlight\">\n<td>Less: Preferred stock dividends<\/td>\n<td class=\"r\">12,000<\/td>\n<\/tr>\n<tr>\n<td>\u00a0 \u00a0 \u00a0 Common stock dividends<\/td>\n<td class=\"r\">8,000<\/td>\n<\/tr>\n<tr>\n<td>Increase in retained earnings<\/td>\n<td class=\"r line-single\">20,000<\/td>\n<\/tr>\n<tr>\n<td>Gross Profit<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$2,426,000<span class=\"u-sr-only\">Double Line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<div class=\"textbox tryit\">\n<h3>PRACTICE QUESTION<\/h3>\n<p>\t<iframe id=\"lumen_assessment_23872\" class=\"resizable\" src=\"https:\/\/assessments.lumenlearning.com\/assessments\/load?assessment_id=23872&#38;embed=1&#38;external_user_id=&#38;external_context_id=&#38;iframe_resize_id=lumen_assessment_23872\" frameborder=\"0\" style=\"border:none;width:100%;height:100%;min-height:400px;\"><br \/>\n\t<\/iframe><\/p>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-4152\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Original<\/div><ul class=\"citation-list\"><li>Interest Coverage. <strong>Authored by<\/strong>: Joseph Cooke. <strong>Provided by<\/strong>: Lumen Learning. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em><\/li><\/ul><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Shared previously<\/div><ul class=\"citation-list\"><li>Principles of Financial Accounting. <strong>Authored by<\/strong>: Christine Jonick. <strong>Located at<\/strong>: <a target=\"_blank\" href=\"https:\/\/web.ung.edu\/media\/university-press\/Principles-of-Financial-Accounting.pdf?t=1601063299615,\">https:\/\/web.ung.edu\/media\/university-press\/Principles-of-Financial-Accounting.pdf?t=1601063299615,<\/a>. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by-sa\/4.0\/\">CC BY-SA: Attribution-ShareAlike<\/a><\/em><\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t 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Jonick\",\"organization\":\"\",\"url\":\"https:\/\/web.ung.edu\/media\/university-press\/Principles-of-Financial-Accounting.pdf?t=1601063299615,\",\"project\":\"\",\"license\":\"cc-by-sa\",\"license_terms\":\"\"}]","CANDELA_OUTCOMES_GUID":"","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-4152","chapter","type-chapter","status-publish","hentry"],"part":857,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/4152","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/users\/90270"}],"version-history":[{"count":11,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/4152\/revisions"}],"predecessor-version":[{"id":5876,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/4152\/revisions\/5876"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/parts\/857"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/4152\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/media?parent=4152"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapter-type?post=4152"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/contributor?post=4152"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/license?post=4152"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}