Question

Scott Ltd sold its patent for $900,000 cash. On the date of sale, the Patent and Accumulated Amortisation accounts had normal balances of $500,000 and $100,000, respectively.

Required:

Assess the immediate impact from the above event on the Interest Cover ratio. In your discussion, identify the numerator and denominator of the ratio; then assess the impact, if any, on that numerator and on that denominator. Finally, write if the ratio improves, worsens, or stays the same based on your analysis.

Answer 1

Cost of Patent	500,000
Accumulated Amortization	100,000
Carrying Value of patent	400,000
Sale Value	900,000
Gain on Sale of Patent	500,000

Immediate Impact: The times interest Earned will Increase

		Numerator		Denominator
Interest Cover ratio	=	Earning before Interest and Tax	/	Interest expenses

So the Numerator i.e Earning before Interest and Tax will increase by 500,000, with no change in the denominator the Interest Coverage Ratio will Increase.

Let's take an Example:

	Before Sale	After Sale
EBIT	600,000.00	1,100,000.00
Interest	200,000.00	200,000.00
Interest Cover ratio	3.00	5.5

So, We can see that Ratio improves due to the sale of Patent.

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