CFA 2018 Question bank 02 Long lived Assets Implic...ial Statements and Ratios

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Long-lived Assets: Implications for Financial Statements and Ratios

Question #1 of 82

Question ID: 462104

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Question #2 of 82

Question ID: 414641

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Question #3 of 82

Question ID: 462092

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Test ID: 7440403

Inindustries wheretherearerapidchangesintechnology relatedtoproductionprocesses, which ofthefollowingcharacteristics willmost likelyindicatethatafirm hasacompetitiveadvantage?

Low capital expenditures. High earningspershare. Low averageageofequipment.

Explanation

Averageageofdepreciableassetsisusefulfortworeasons:

1. Toassess how competitivethecorporation will begoingforward (olderassetsarelessefficient). 2. Estimatefinancingrequiredformajorcapitalexpenditurestoreplacedepreciatedassets.

Whilelow capitalexpendituresmay resultin higherearningsintheshortrun, inthelongrun, thecompany may finditselfatacomparative disadvantageiftechnologicalchangesarerapidly increasing. EPSisnotcomparable betweencompanies.

The MaderCorporationleasesanassetforfive years with leasepaymentsof $10,000 per year.If Maderclassifiesthelease asafinancelease, which financialstatementsareaffectedattheendofthefirst year?

Income statement only.

Statementofcash flows, incomestatement, and balancesheet. Incomestatementand balancesheetonly.

Explanation

Theclassificationofaleaseasafinanceleasecreatesanasset, adebtobligation, financingcash flows (amortizationofthe loan), andoperatingcash flows (interestexpense).

Which ofthefollowingstatementsaboutdepreciationisleastaccurate?

Return on assets is initiallyhigher using straight-line depreciation than it is using accelerated depreciation.

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ᅚ C)

Question #

4 of 82

QuestionID: 414521

Question #

5 of 82

QuestionID: 414519

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ᅞ B) ᅚ C)

Forafirm with increasingcapitalexpenditures, accelerateddepreciationmethodstendto increase both netincomeandstockholders' equity whencomparedtostraight-line depreciation.

Explanation

Forafirm with increasingcapitalexpenditures, accelerateddepreciationmethodstendtodecrease both netincomeandstockholders'

equity whencomparedtostraight-linedepreciation.

Assumingthefirmcontinuestoinvestinnew assets, thefollowingrelationships hold.Theserelationships willeventually reverseifthe firm'scapitalexpendituresdecline.

StraightLine Accelerated(DDB & SDY) Depreciation Expense Lower Higher

NetIncome Higher Lower

Assets Higher Lower

Equity Higher Lower

ReturnonAssets Higher Lower

Returnon Equity Higher Lower

Animpairment write-downisleastlikelyto decreaseacompany's: future depreciation expense.

debt-to-equity ratio.

assets.

Explanation

Animpairment write-downreducesequity and hasnoeffecton debt.The debt-to-equity ratio would thereforeincrease.

MarcelInc.isalargemanufacturingcompany based inthe U.S. butalsooperatinginseveral Europeancountries. Marcel has

long-lived assetscurrently inusethatarevalued onthe balancesheetat $600 million.Thisincludespreviously recognized impairmentlossesof $80 million.Theoriginalcostoftheassets was $750 million.Thefairvalueoftheassets was determined inaprofessionalappraisalto be $690 million.Assumingthat Marcelreportsunder U.S. GAAP, thenew appraisaloftheassets' valuemostlikely resultsin:

an $80 million gain on income statement and $10 million gain in other comprehensive income.

a $90 milliongaininothercomprehensiveincome.

nochangeto Marcel'sfinancialstatements.

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Question #6 of 82

QuestionID: 462109

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Question #7 of 82

QuestionID: 414627

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Question #8 of 82

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ᅚ A) ᅞ B) ᅞ C)

Under U.S. GAAP, long-lived assetsarereported onthe balancesheetat depreciated costlessany impairmentlosses ($750 millionoriginalcostless $70 millionaccumulated depreciationand less $80 millionimpairmentloss, foranetamountof $600 million).Increasesaregenerally prohibited with theexceptionofassets held forsale. Sincetheseassetsarecurrently inuse, thisexception doesnotapply.Therefore, Marcelmay notrevaluetheassetsupward.

Inasales-typelease, alessorrecognizesagrossprofitattheinceptionoftheleaseequalingthe: sale price of the leased asset plus the present value of the minimum lease

payments.

presentvalueoftheminimumleasepaymentslessthecostoftheleased asset. salepriceoftheleased assetlessthepresentvalueoftheminimumleasepayments.

Explanation

Inasales-typelease, theimplicitinterestrateissuch thatthepresentvalueof MLP isthesellingpriceoftheasset.Atthetime

oftheleaseinception, thelessor willrecognizeagainequalingthepresentvalueofthe MLPs, lessthecostoftheleased asset.

Which ofthefollowingstatementsthatclassify aleaseasafinanceleaseunder U.S. GAAP isleastaccurate? Title is transferred at the end of the lease period.

Thepresentvalueoftheleasepaymentsisatleast80% ofthefairmarketvalueofthe asset.

A bargainpurchaseoptionexists.

Explanation

Foraleaseto beclassified asafinance (capital)leasethepresentvalueoftheleasepaymentsmust beatleast 90% ofthe

fairmarketvalueoftheasset.

Afirmrevaluesitslong-lived assetsupward.Allotherthingsequal, which ofthefollowingfinancialimpactsisleastlikelyto occur?

Higher profitability in the periods after revaluation. Lowersolvency ratios.

Higherearningsintherevaluationperiod.

Explanation

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Question #9 of 82

QuestionID: 414489

Question #10 of 82

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Question #11 of 82

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therefore, lowerprofitability intheperiodsafterrevaluation.Therecould be higherearningsintherevaluationperiod because theremay beimpairmentlossesthatcan bereversed ontheincomestatement. Otherwise, there will beanadjustmentto

earningsthrough othercomprehensiveincome. Solvency ratios (i.e. debttoequity) will decreasesincetheincreaseinassets will be balanced by anincreaseinequity. Higher denominatorsand unchanged numerators willresultinlowersolvency ratios.

Capitalized interestcostsaretypically reported inthecash flow statementasanoutflow from: operating.

financing.

investing.

Explanation

Capitalized interestcostsarereported asCFIonthestatementofcash flows, asthey aretreated aspartofthecostofthe constructed capitalasset.

Underafinancelease (versusanoperatinglease) which ofthelessee'sfinancialratios will be higher? Asset turnover.

Returnonequity. Debt/equity.

Explanation

The debt/equity ratio will be higher becausethefinanceleaserequiresthecreationofalong-termliability onthe balance

sheet.

StatementofFinancialAccounting Standard (SFAS)86 requiresthatcostsincurred toestablish thefeasibility ofcomputer

softwaremust be:

capitalized only after the software is completely developed. expensed oncetheeconomicfeasibility isestablished.

viewed likeResearch & Development (R&D)costsand expensed asincurred.

Explanation

SFAS 86 requiresthatallthecostsincurred inestablishingsoftwarefeasibility beviewed asR&D costsand expensed as

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Question #12 of 82

QuestionID: 448956

Question #13 of 82

QuestionID: 462065

Questions #14-19 of 82

Question #14 of 82

QuestionID: 462078

ᅚ A)

LakesideCo.recently determined thatoneofitsprocessingmachines has becomeobsoleteafter7 yearsofuseand,

unexpectedly, hasnosalvagevalue.Themachine was being depreciated overausefuleconomiclifeof10 years. Which ofthe

followingstatementsismostconsistent with this discovery?

Lakeside Co. will owe back taxes.

Historically, economic depreciation wasoverstated inthefinancialstatements. Historically, economic depreciation wasunderstated inthefinancialstatements.

Explanation

Historically, economic depreciation wasunderstated.Ifanasset becomesobsoleteand itsusefullifeislessthanexpected, accountingmethodsfor depreciation haveunderstated theeconomic depreciation.Inaddition, ifthereisnosalvagevalue whenpositivesalvagevalue wasexpected, theunderstatementproblemiscompounded.

Train, Inc.'scash flow fromoperations (CFO)in2004 was $14 million.Trainpaid $8millioncash toacquireafranchiseatthe beginningof2004 that wasexpensed in2004.IfTrain had elected toamortizethecostofthefranchiseovereight years, 2004 cash flow fromoperations (CFO) would have been:

$21 million. $22million. unchanged.

Explanation

IfTrain decided toamortizethefranchisecost, it would becapitalized and noneofthecash expended would flow though CFO, and allofthe $8million would beadded backtoCFO. Subsequentamortization would beanon-cash expenseand would be added backto NItoarriveatCFO.

ManagementoftheBeef, Etc.corporation haschanged certainaccountingassumptionsin hopesofimprovingthepublic

perceptionofthecompany'sprospects.Theseaccountingassumptionsrelateprimarily tothetreatmentofcapitalized expensesand long-termleases.Lisa Kelps, CFA, wantstoadjustthefinancialstatementstomakethemmorecomparable across yearsand tosimilarfirmsinthesameindustry.

Whencomparingacompany thatexpenses with acompany thatcapitalizesthesameexpense, ananalystcanadjustthecash flow statementofthecompany thatcapitalizes by:

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Question #18 of 82

QuestionID: 462082

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Question #19 of 82

QuestionID: 462083

Question #20 of 82

QuestionID: 462108

expensesthesecosts, thecompany thatcapitalizesinterestcostismostlikelytoreporta: lower interest coverage ratio and lower fixed asset turnover ratio.

higherinterestcoverageratioand lowerfixed assetturnoverratio. higherinterestcoverageratioand higherfixed assetturnoverratio.

Explanation

Companiesthatcapitalizeinterestcost willreportlowerinterestexpense (and higherinterestcoverageratio)and higherfixed assets (lowerfixed assetturnoverratio). (LOS 18.a)

Which ofthefollowingstatementsaboutfixed assetsismostaccurate?

Average remaining life can be estimated as average age minus average useful life.

Averageagecan beestimated assumofaverageusefullifeand averageremaining life.

Averageusefullifecan beestimated asthesumofaverageageand average remaininglife.

Explanation

Averageusefullifecan beestimated asthesumofaverageageand averageremaininglife. (LOS 18.d)

Compared toacompany thatusesstraightline depreciation, acompany thatusesaccelerated depreciationismostlikelyto have:

higher activity ratios and stronger solvency ratios. loweractivity ratiosand weakersolvency ratios. higheractivity ratiosand weakersolvency ratios.

Explanation

Accelerated depreciation willlead tolowerreported incomeand assetvaluesinearly years.Thelowerincome willreduce reported equity (hence weakersolvency ratios)and lowerassetvalues willincreasethefixed-assetturnover (activity)ratios. (LOS 18.d)

Afirmusingstraight-line depreciationreportsthefollowingfinancialinformation: Grossinvestmentinfixed assetsof $89,167,205.

Accumulated depreciationof $35,341,773.

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Question #21 of 82

QuestionID: 462066

Question #22 of 82

QuestionID: 462073

9.10years. 22.95 years. 2.52 years.

Explanation

Averageageoffixed assets = accumulated depreciation / annual depreciation = $35,341,773 / $3,885,398 = 9.10.

Which ofthefollowingisleastlikelyto beaproblem with accountingforinternally generated intangibleassets?

Costs of developing these assets may not be easily separable. Thepotential benefitsarespread overalongtimeperiod.

Determiningtheeconomiclife.

Explanation

Theproblems with accountingforinternally generated intangibleassetsare: determinationofeconomiclifeand separationof

thecostfor development.

IncomestatementinformationforQuickCorp.forthe yearsended December31, 20X0 and 20X1 wasasfollows (in $ millions):

20X0

20X1

S

a

les

3 0,000,000

32 ,000,000

Cost

of

G

oo

d

s

S

ol

d

(

1 6,000,000

)

(

17 ,000,000

)

Gr

oss

Pr

ofit

1 4,000,000

1 5,000,000

Amo

r

ti

za

tion

of

F

ra

n

ch

ise

(

1 ,500,000

)

(

1 ,500,000

)

O

t

h

e

r E

xpenses

(

7 ,000,000

)

(

7 ,000,000

)

N

et

In

c

ome

5,500,000

6,500,000

Quickacquired afranchisein20X0 for $15,000,000 and elected toamortizethecostover10 years.Ignoringtaxes, ifQuick had expensed thefranchisecostin20X0 instead ofamortizingit, netincomefor20X0 and 20X1 would be:

20X0 20X1

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Questions #23-28 of 82

Question #23 of 82

QuestionID: 462085

Question #24 of 82

QuestionID: 462086

ᅚ A) ᅞ B) ᅞ C) Explanation

Ifthefranchisecost wereexpensed, amortization would beeliminatedandfranchiseexpense would befully takenin20X0.20X0 net income would be $5,500,000 + 1,500,000 - $15,000,000= -$8,000,000, and20X1netincome would be $6,500,000 + $1,500,000= $8,000,000.

Doug Dalby, CFAand LukeBrown, CFAareconsultingtotheexecutive board of Housekeeping Enterprises (Housekeeping) concerningstrategicchangestothecompany's balancesheet.

Housekeepingisconsideringchangingitsinventory accountingmethod toFIFO fromLIFO. Dalby briefsthe board onthe effectoffalling/risingpricesand stableorincreasinginventory quantities, oncostofgoodssold and cash flows, dependingon inventory accountingmethod.

Housekeeping would liketocapitalizevariouscostsit had previously beenexpensed, butis worried aboutthechange being refused by itsauditors.The board asksBrown which costsaremostlikely to becapitalized under U.S. GAAP.

If Housekeepinguseslastin, firstout (LIFO)reportsaninventory balanceof $44,000 and aLIFO reserveof $8,000 (assumea 40% effectivetaxrate), theestimated valuefortheinventory onafirstin, firstout (FIFO) basis would beclosestto:

$36,000. $48,800. $52,000.

Explanation

FIFO INV = LIFO INV + LIFO Reserve X = 44,000 + 8,000

X = 52,000

Theeffectivetaxrateisnotused inthiscalculation. (Study Session 5, LOS 17.b)

Inperiodsofrisingpricesand stableorincreasinginventory quantities, acompany usingLIFO ratherthanFIFO willreportcost

ofgoodssold which is:

higher. lower.

thesame.

Explanation

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Question #25 of 82

QuestionID: 462087

Research and development costs associated with software development. Thecostsassociated with aninternally created trademark.

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Question #29 of 82

QuestionID: 462076

Question #30 of 82

QuestionID: 414635

Question #31 of 82

QuestionID: 462094

ᅞ A) ᅚ B) ᅞ C) Explanation

Thecostofanacquisitionofapatentfromanoutsideentity iscorrect becausethiscostmay becapitalized. Whenpatentsand copyrightsareinternally developed, only thelegalfeesincurred forregistrationcan becapitalized. However, ifthepatentsand copyrightsarepurchased fromotherentities, fullacquisitioncostcan becapitalized. (Study Session 5, LOS 18.a)

Under U.S.generally accepted accountingprinciples (GAAP), which ofthefollowingcostsassociated with intangibleassetsis

mostlikelyto becapitalized?

The cost of an acquisition of a patent from an outside entity. Thecostsassociated with aninternally created trademark.

Research and developmentcostsassociated with software development.

Explanation

Thecostofanacquisitionofapatentfromanoutsideentity iscorrect becausethiscostmay becapitalized.

Onthelessee'scash flow statement, theprincipalportionofafinanceleasepaymentisa: operating cash flow.

financingcash flow.

investingcash flow.

Explanation

Theprincipalportionofafinanceleasepaymentisafinancingcash outflow forthelessee.Theinterestportionisanoperating cash outflow.

MeyerInvestmentAdvisory and Smith BrothersInvestmentsareoperationally identicalexceptthat Meyercapitalizessome coststhat Smith expenses.Compared to Smith, Meyerislikely to have:

higher debt/equity ratio and higher debt/assets ratio.

highercash flowsfromoperationsand lowercash flow frominvesting.

lowerprofitability (ROA&ROE)inearly yearsand higherinlater years.

Explanation

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Question #32 of 82

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ᅞ B) ᅞ C)

Question #33 of 82

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Question #34 of 82

QuestionID: 462093

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ᅚ C)

expensingcosts, firmsthatcapitalizecosts will havesmaller debttoequity ratiosand higherinitialROAs, butlowerROAsin thefuture.

Forafinancelease, theamountrecorded initially by thelesseeasaliability willmostlikely: equal the present value of the minimum lease payments at the beginning of the lease.

belessthanthefairvalueoftheleased asset.

equalthetotaloftheminimumleasepayments.

Explanation

With afinancelease, both anassetand liability arereported onthelessee's balancesheet, with leasepayments divided betweeninterestand principalcomponents.Thefuturepaymentsonprincipaland interestmust be discounted topresent

valueatthe beginningofthelease.

Ifalesseeentersintoafinanceleaseratherthananoperatinglease, itcanexpectto havea:

higher return on assets. lower debt-to-equity ratio. higher debt-to-equity ratio.

Explanation

Leasingtheasset with anoperatingleaseavoidsrecognitionofthe debtonthelessee's balancesheet. Havingfewerassets

and liabilitiesonthe balancesheetthan would existiftheassets werepurchased increasesprofitability ratios (e.g., returnon assets)and decreasesleverageratios (e.g., debt-to-equity ratio).Inthecaseofafinancelease, theassetsarereported on the balancesheetand are depreciated.

Forfirmsthatexpenseratherthancapitalizecosts, which ofthefollowingstatementsisleastaccurate? Net cash flows are the same regardless of which method is used.

Higher debt/equity and debt/assets willoccur becauseoflowerassetand equity levels.

LowerROAand ROE willoccur becauseof higherassetand equity levelsintheearly years.

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Question #35 of 82

QuestionID: 414522

Question #36 of 82

QuestionID: 462106

Question #37 of 82

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Firmsthatexpensecostsratherthancapitalizecosts will havelowerROE and lowerROAinearly years.Thisoccurs because

oflowerprofitsand not becauseof higherassetsand equity levels.Actually, theassetsand equity arelower duetoexpensing thecosts.

Ananalyst determined thefollowinginformationconcerningFranklin, Inc.'sstampingmachine:

Acquired seven yearsagofor $22million Straightlinemethod used for depreciation Usefullifeestimated to be12 years

Salvagevalueoriginally estimated to be $4 million

Thestampingmachineisexpected togenerate $1,500,000 per yearforfivemore yearsand willthen besold for $1,000,000. Under U.S. GAAP, thestampingmachineis:

impaired because expected salvage value has declined.

impaired becauseitscarryingvalueexceedsexpected futurecash flows.

notimpaired.

Explanation

Thecarryingvalueofthestampingmachineisitscostlessaccumulated depreciation. Depreciationtakenthrough 7 years was ($22,000,000 - $4,000,000) / 12 × 7 = $10,500,000, socarryingvalueis $22,000,000 - $10,500,000 = $11,500,000.Because the $11,500,000 carryingvalueismorethanexpected futurecash flowsof (5 × $1,500,000) + $1,000,000 = $8,500,000, the

stampingmachineisimpaired.

Twocompaniesinthesameindustry aresimilarinallaspectsexceptthattheaverageageofthe depreciableassetsfor

Company Bis10 timesgreaterthantheaverageageofthe depreciableassetsforCompany A. Which ofthefollowing

statementsisleastlikelyaccurate? Company B will have:

higher taxes.

lower depreciationexpense.

acompetitiveadvantageinthefuture.

Explanation

Company A willmostlikely haveacompetitiveadvantagefromusingnewerequipmentonaverage.Company B'sassetsare

mostly depreciated.Therefore, depreciationexpense will belowerand ifallotheraspectsaresimilar, theearningsand taxes forCompany B will be higher.

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Question #38 of 82

QuestionID: 414645

Question #39 of 82

QuestionID: 462105

Question #40 of 82

QuestionID: 462110

todouble-decliningmethodofdepreciation, which ofthefollowingstatementsisthemostaccurate?

Asset turnover ratio will decrease over the life of the asset. Currentratio willincreaseoverthelifeoftheasset.

ReturnonInvestment willincreaseoverthelifeoftheasset.

Explanation

With theuseofany acceleratedmethodofdepreciation, thedeductionsinassetsandnetincomearegreatestintheearly years.For

DDB, thegreatestimpactis year1.After year1, netincome willincrease, increasingROI.

Classifyingaleaseasanoperatingleaseforalessee, asopposed toafinancelease, willresultin:

CurrentRatio Debt/Equity Ratio AssetTurnover Ratio

Higher Lower Lower

Lower Lower Higher

Higher Lower Higher

Explanation

Foralesseeusingoperatingleases, thecurrentratio will be higher, the debt/equity ratio will belower, and theassetturnover will be higherthanthey would be with financeleases. With operatingleases, assetsand liabilitiesarelower.

Ananalyst willmostlikelyusetheaverageageofdepreciableassetstoestimatethecompany's:

near-term financing requirements.

earningspotential.

cash flows.

Explanation

Averageageofdepreciableassetsisusefulfortworeasons:

1. Toassess how competitivethecorporation will begoingforward (olderassetsarelessefficient).

2. Toestimatefinancingrequiredformajorcapitalexpendituresinthenear-termtoreplacedepreciatedassets.

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ᅞ A)

ᅚ B)

ᅞ C)

Question #41 of 82

QuestionID: 462107

Question #42 of 82

QuestionID: 414485

ᅚ A)

ᅞ B)

ᅞ C)

Question #43 of 82

QuestionID: 414633

ᅞ A)

Firms that capitalize their leases will have lower current ratios and higher debt to equity ratios than firms that structure their leases as operating leases. Ifthelessorisonly financingthepurchaseofanasset, theleaseisconsidered to bea directfinancingleaseand grossprofitsarerecognized attheinceptionofthelease. Theinterestrateimplicitinaleaseisthe discountratethatthelessorused to determinetheleasepayments.

Explanation

With a directfinancinglease, thelessorrecognizesprofitasinterestrevenueoverthelifeofthelease.Asales-typelease allowsthelessortorecognizeprofitsattheleaseinception.

Endinggrossinvestment/depreciationexpenseisused toestimatetheaverage: age as a percent of depreciable life.

depreciablelife.

age.

Explanation

Average depreciablelifeisapproximated by:endinggrossinvestment / depreciationexpense

Whencomparingcapitalizingversusexpensingcosts which ofthefollowingstatementsismostaccurate? Capitalizing costs creates higher cash flows from operations and lower cash

flows from investing.

Capitalizingcostscreateslowercash flowsfromoperationsand highercash flows frominvesting.

Expensingcostscreateslowercash flowsfromoperationsand lowercash flowsfrom

investing.

Explanation

Although netcash flowsarenotaffected by thechoiceofcapitalizationorexpensing, thecomponentsofcash flow are

affected.Because, afirmthatcapitalizesclassifiestheexpenditureasinvesting (notoperations), cash flow fromoperations will be higherforfirmsthatcapitalizeand investingcash flows will belowerthanthatofanexpensingfirm.

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ᅞ B) ᅚ C)

Question #44 of 82

QuestionID: 414497

Question #45 of 82

QuestionID: 462071

Question #46 of 82

QuestionID: 414486

alowercurrentratio.

highercash flow fromfinancing duringtheleaseperiod.

Explanation

Sinceaportionoftheleasepaymentistreated asrepaymentofprincipalunderafinancelease, cash flow fromfinancing will belower.

Acompany isswitchingfromstraight-linedepreciationtoanacceleratedmethodofdepreciation.Assumingallotherrevenueand expensesareatthesamelevelsforthenextperiod, switchingtoanacceleratedmethod willmostlikelyincreasethecompany's:

net income/sales ratio. fixedassetturnoverratio.

totalassetsonthe balancesheet.

Explanation

Theuseofanaccelerateddepreciationmethod willincreasedepreciationexpensesearly intheasset'slife.The bookvalueoftheasset

will belower.Fixedassetturnoverratio (sales/fixedassets) willincrease, becausethe bookvalueofthefixedassets will belower.

Compared with firmsthatexpensecosts, firmsthatcapitalizecostscan beexpected toreport: lower asset levels and higher equity levels in the earlyyears of the asset's life. higherassetlevelsand lowerequity levelsintheearly yearsoftheasset'slife. higherassetlevelsand higherequity levelsintheearly yearsoftheasset'slife.

Explanation

Thecapitalized costisrecorded asanasset, which isthenexpensed intheformof depreciationoverfuture years. Spreading the depreciationoutoverfuture yearscausesnetincometoincreasealong with retained earningsand equity intheearly yearsoftheasset'slife.

Which ofthefollowingstatementsregardingcapitalizingversusexpensingcostsisleastaccurate? Total cash flow is higher with capitalization than expensing.

Capitalizationresultsin higherprofitability initially.

Cash flow frominvestingis higher with expensingthan with capitalization.

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Question #47 of 82

QuestionID: 414631

Question #48 of 82

QuestionID: 414488

Question #49 of 82

QuestionID: 414638

ᅞ A)

ᅞ B)

ᅚ C)

Totalcash flow is higher with capitalizationthanexpensingisleastaccurate becausetotalcash flow would bethesameunder both methods, notconsideringtaximplications.

Ina direct-financinglease, theimplicitrateissuch thatthepresentvalueoftheminimumleasepayments:

equals the cost of the leased asset. islowerthanthecostoftheleased asset.

equalsthesalepriceoftheleased asset.

Explanation

Ina direct-financinglease, theimplicitrateissuch thatthepresentvalueofthe MLPsequalsthecostoftheleased asset. Thus, atleaseinceptionthetotalassets donotchangeand nogainisrecognized.

Capitalizinginterestcostsrelated toacompany'sconstructionofassetsforitsownuseisrequired by: both IFRS and U.S. GAAP.

IFRS only. U.S. GAAP only.

Explanation

Both U.S. GAAP and IFRS requirecompaniestocapitalizetheinterestthataccrues duringatheconstructionofcapitalassets fortheirownuse.

Which ofthefollowingstatementsaboutleasesisleastaccurate?

In the first years of a finance lease, the lessee's debt to equity ratio is greater than it would have been if the firm had used an operating lease.

Allelseequal, whenaleaseiscapitalized thelessee'sincome willriseoverthetermof

thelease.

Inthefirst yearsofafinancelease, thelessee'scurrentratioisgreaterthanit would have been had thefirmused anoperatinglease.

Explanation

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Question #

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QuestionID: 414491

Question #

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QuestionID: 414487

Question #

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QuestionID: 462069

Intheearly years, thecapitalizedleaseexpense (interestplusdepreciation)isgreaterthaninthelater years becauseinterest

expensedecreasesovertime.Lessexpenses = moreincome.

Inthefirst yearsofafinanceleasethelessee'sdebttoequity ratio will begreaterthanifthefirm hadusedanoperatinglease becauseinthecaseofthefinancelease, thenumeratoriscomprisedof (debt + lease), whilethenumeratorinthecaseofthe

operatingleaseis (debt)only.Inaddition, thegreatercapitalizedleaseexpenseflowsthrough todecreaseshareholder's

equity (thedenominator).

Afirmthatcapitalizesratherthanexpensingcosts will have: lower profitability in the earlier years.

lowercash flowsfromoperations.

lowercash flowsfrominvesting.

Explanation

Afirmthatcapitalizescostsclassifiesthemasaninvestingcash flow ratherthananoperatingcash flow.Investingcash flows will belowerandcash flow fromoperations will be higher whencostsarecapitalized.

Which ofthefollowingstatementsregardingthecapitalizationofanexpenseisleastaccurate? Capitalized expenses increases equity.

Capitalizinganexpenselowerscurrentperiodnetincome. Capitalizinganexpensecreatesanasset.

Explanation

Capitalizingexpensesreducescurrentperiodexpenses by theamountcapitalized.Theamountcapitalizedisaddedtoassets which increasesequity by increasingnetincomeandretainedearningsinthecurrentperiod.

SelectedinformationfromYorktownCorp.'sfinancialstatementsforthe yearended December31, 2004 wasasfollows (in $ millions):

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Question #

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Question #

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QuestionID: 414622

Question #

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QuestionID: 462067

In2004, Yorktownpaid $10 millioncash topurchaseafranchise.Thefranchisecost wasfully expensedin2004. Ifthe

company hadelectedtoamortizethefranchisecostover 5 yearsinsteadofexpensingit, Yorktown'sdebtratio would (ignoring taxes):

increase from 0.158 to 0.184.

decreasefrom 0.184 to 0.138. decreasefrom 0.158to 0.138.

Explanation

Thedebtratioistheratiooftotaldebt (which excludesaccountspayable)tototalassets.Totalassetsmustequaltotal liabilitiesandequity.Yorktown'stotaldebtratio wasTotaldebt / Totalassets = $9 / $57 = 0.158.Ifthefranchisecost were amortized, retainedearnings wouldincrease by $8million ($10 cost, less $10/5 = $2millionofamortization.)Thedebtratio woulddecreaseto $9 / ($57 + $8) = 0.138.

Dobkin Company decidesto expense coststhatit would have otherwise capitalized. Comparedto capitalizing, expensing these costs will

resultin:

lower asset levels and lower liability levels.

lower assetlevelsand higher equity levels.

lower assetlevelsandlower equity levels.

Explanation

Expensing instead of capitalizing resultsinlower assets. Sincetheentireexpenseis recognizedinthe currentperiod (whereas only a portion of theexpenditureisamortized when capitalizing), netincome (andthereforeequity, via retainedearnings) islower with expensing

than with capitalizing. Liabilitiesare unaffected.

Thelessee hasanincentivetoclassify aleaseasanoperatinglease, ratherthanasafinancelease, becauseanoperating

lease:

has no risk involved because the lessor assumes all risk. haspaymentsthatarelessthanacapitallease'spayments. doesnotappearonthe balancesheet.

Explanation

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Questions #

56 -

6 1 of 82

Question #

56 of 82

QuestionID: 462098

Question #

5 7 of 82

QuestionID: 472477

Question #

5 8 of 82

QuestionID: 462100

Under U.S. GAAP, which statementisCORRECT?

Goodwill cannot be recognized and capitalized in a purchase transaction. Research anddevelopmentcostsarenotexpensed.

Purchasedpatentandcopyrightcostsarenotexpensed.

Explanation

Purchasedpatentandcopyrightcostsarenotexpensediscorrect becausethesecostsarecapitalized.

Amanufacturingfirmreportsthefollowinginitsfinancialstatements: Grossplantandequipment: $2,700,000.

Depreciationexpense: $235,000. Accumulateddepreciation: $1,850,000.

Theaverageusefullifeofplantandequipmentisclosestto: 11.5years.

15.4 years. 19.4 years.

Explanation

Theaverageusefullife = grossinvestment / depreciationexpense $2,700,000 / $235,000 = 11.49.

(LOS18.d)

Theaverageageofplantandequipmentisclosestto: 19.4years.

11.5 years. 7.9 years.

Explanation

Theaverageage = accumulateddepreciation / depreciationexpense $1,850,000 / $235,000 = 7.87

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Question #

6 2 of 82

QuestionID: 462075

Question #

6 3 of 82

QuestionID: 462096

Question #

64 of 82

QuestionID: 462095

Under U.S. Generally AcceptedAccounting Principles (GAAP), developmentcostofpatentsandcopyrightscan becapitalized:

when developed internally. whenpurchasedfromotherentities.

whenpurchasedordevelopedinternally butexcludingregistrationcosts.

Explanation

Whenpatentsandcopyrightsareinternally developed, only thelegalfeesincurredforregistrationcan becapitalized. However, ifthepatentsandcopyrightsarepurchasedfromotherentities, fullacquisitioncostcan becapitalized.

Takinganimpairmentoflong-livedassets willresultin: increased deferred tax liabilities.

decreaseddebt/equity ratio.

increasedfutureROA.

Explanation

Infuture years, lessdepreciationexpenseisrecognizedonthe written-downassetresultingin highernetincomeandreturn

onassetssinceROA = NI/TotalAssets. Deferredtaxliabilitiesrelatedtotheassetdecrease becausetheimpairmentcannot

bedeductedfromtaxableincomeuntiltheassetissoldordisposedof.Thedebt/equity ratioincreases becauseequity

decreases whiledebtisunchanged.

SelectedinformationfromIngotCompany'sfinancialstatementsforthe yearended December31, 20X4, wasasfollowsprior totheconsiderationofitsimpairedasset write-down (in $):

Ca

s

h

120,000

Shor

t

-

te

rm D

e

b

t

290,000

Accou

nts

R

e

c

ei

vab

le

200,000

Lo

n

g-

te

rm D

e

b

t

740,000

I

n

v

ent

ory

300,000

Commo

n

S

t

ock

800,000

Pro

pe

r

t

y P

l

a

nt

& Eq. (

net

) 1,700,000

R

et

a

ined

Ear

nin

g

s

490,000

2,320,000

IngotCompany'sexcavationmachineispermanently impaired.Itspurchaseprice was $1,600,000 anditsaccumulated depreciation was $800,000 through 20X4.Thepresentvalueofitsfuturecash flowsis $500,000.

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Question #

65 of 82

QuestionID: 414512

Question #

66 of 82

QuestionID: 414626

decrease from 0.44 to 0.40.

Explanation

The write-downoftheexcavationmachineintheamountof ((($1,600,000 − $800,000) − $500,000) =) $300,000 decreases retainedearningsfrom $490,000 to $190,000.Thetotaldebttototalcaptitalratioincreasesfrom (($290,000 + $740,000) / ($290,000 + $740,000 + $800,000 + $490,000) =) 0.44 to (($290,000 + $740,000) / ($290,000 + $740,000 + $800,000 + $190,000) =) 0.51.

DavisInc.isalargemanufacturingcompany operatinginseveral Europeancountries. Davis haslong-livedassetscurrently in

usethatarevaluedonthe balancesheetat $600 million.Thisincludespreviously recognizedimpairmentlossesof $80 million. Theoriginalcostoftheassets was $750 million.Thefairvalueoftheassets wasdetermined by inindependentappraisalto be $690 million. Which ofthefollowingentriesmay DavisrecordunderIFRS?

$80 million gain on income statement and a $10 million revaluation surplus. $90 milliongainonincomestatement.

$90 millionrevaluationsurplus.

Explanation

UnderIFRS, firmsmay choosetoreportlong-livedassetsatfairvalue. Upwardrevaluationsarepermittedand willresultina

gainrecognizedontheincomestatementtotheextentitreversesapreviously recognizedloss.Any excessisreportedasa

revaluationsurplus, adirectadjustmenttoequity.Inthiscase, thecarryingvalueoftheassetsis $600 million ($750 million

originalcostless $70 millionaccumulateddepreciationandless $80 millionimpairmentloss).Thefairvalueis $690 million. Of the $90 millionexcessoffairvalueovercarryingvalue, $80 millionisrecognizedasagainontheincomestatementtoreverse

the $80 millionimpairmentlossthat waspreviously recognized.Theremaining $10 millionisrecordedasarevaluationsurplus

inshareholders' equity.

Underanoperatinglease (versusafinancelease) which ofthefollowingis higherforthelessee? Cash flow from financing.

Assets.

Cash flow fromoperations.

Explanation

Thelessee'scash flowsfromfinancing will be higherforanoperatinglease becausethepaymentsmadeforanoperating

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Question #

6 7 of 82

QuestionID: 414644

ᅚ A)

ᅞ B) ᅞ C)

Question #

6 8 of 82

QuestionID: 414520

Question #

69 of 82

QuestionID: 462072

ᅞ A)

ᅚ B) ᅞ C)

Question #7

0 of 82

QuestionID: 414629

Which ofthefollowingstatementsregardingfinanceandoperatingleasesisleastaccurate?

For financial reporting of finance and operating leases, no entry is required on the lessee's balance sheet at the inception of the lease.

Assetturnoveris higherforthelessee with anoperatingleasethanafinancelease. Duringthelifeofanoperatinglease, therentexpenseequalstheleasepayment.

Explanation

Iftheleaseisanoperatingleasethereisnoentry madeonthe balancesheetforthelessee.Forfinanceleases, theleased

assetandliability arerecognizedonthe balancesheet by theamountequaltothepresentvalueoftheminimumlease

paymentsusingasthediscountratethelowerofthelessor'simplicitrateorthelessee'sincremental borrowingrate.

Under U.S. GAAP, anassetisimpaired when:

accumulated depreciation plus salvage value exceeds acquisition costs.

thepresentvalueoffuturecash flowsexceedsthecarryingamountoftheasset. thefirmcannolongerfully recoverthecarryingamountoftheasset.

Explanation

Anassetisimpairedifitsfuturecash flows (undiscounted)arelessthanitscarryingvalue.

ThemanagementofBergerInvestments haschangedtheirpolicy and willcapitalizesomecostsinsteadofexpensingthem. Duetothenew policy, Berger will:

report a smooth income pattern initially,but income variabilitywill increase over time.

havesmootherreportedincomeovertime.

havelowerincomevariability asitgrows, butthevariability willincreaseasthefirm matures.

Explanation

Ifmanagementdecidestocapitalizecostsinsteadofexpensingthem, it willreportsmootherreportedincomeovertime.Ifthe

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ᅞ A)

ᅞ B) ᅚ C)

Question #71 of 82

QuestionID: 414637

Question #72 of 82

QuestionID: 414642

ᅞ A) ᅚ B)

ᅞ C)

Question #73 of 82

QuestionID: 414623

Which ofthefollowingisleastlikelyoneofthecriteriaunder U.S. GAAP forclassifyingaleaseasafinancelease? The: term of the lease is 75% or more of the estimated economic life of the leased

property.

leasecontainsa bargainpurchaseoption.

lessorretainsownershipoftheproperty attheendoftheleaseterm.

Explanation

Iftheleasetransfersownershipoftheproperty tothelesseeattheendoftheleaseterm, thelessee willclassify theleaseasa

financelease.

Foragivenleasepaymentandterm, which ofthefollowingisleastaccurateregardingtheeffectsoftheclassificationofthe leaseasafinanceleaseascomparedtoanoperatinglease?

The lessee's asset turnover will be lower for a finance lease. Thelessee'scurrentratio will be higherforafinancelease. Thelessee'sdebt-to-equity ratio will be higherforafinancelease.

Explanation

Thelessee'scurrentratio will belower becausethecurrentportionofthefinanceleaseincreasescurrentliabilities, hence

reducingthecurrentratio.

Which ofthefollowingstatementsregardingadirectfinancingleaseisleastaccurate?

The lessor recognizes no gross profit at the inception of the lease.

Interestrevenueonthelessor'sincomestatementequalstheimplicitinterestrate

timestheleasepayment.

Theprincipalportionoftheleasepaymentisacash inflow frominvestingonthe lessor'scash flow statement.

Explanation

Interestrevenuesarecalculated by multiplyingtheimplicitinterestrate by netreceivablesatthe beginningoftheperiod.