chapter 8 excersize

Question 1

On January 1, Year 1, a firm purchases a
machine for $68,000 that has an estimated
useful life of five years, at which time it will
have a salvage value of $10,000. Using the
double-declining balance method, Year 3
depreciation expense is closest to:
A. $27,200
B.$16,320
C. $9,792

Answer 1

Ans: C
Double-declining balance method does not
consider salvage value when calculating
depreciation. So depreciation expense on:
Year 1= 2/5($68,000-0)= $27,200
Year 2= 2/5($68,000-27,200)=$16,320
Year 3= 2/5 ($68,000-27,200-16,320)=$9,792

Question 2

The effects on a firm’s financial statement
in the initial year when cost of an asset is
expensed rather than capitalized are:
A. Pre-tax cash flow is lower and the debt-to-
equity ratio is higher.
B. Pre-tax cash flow remains the same and
the debt-to-equity ratio is lower.
C. Pre-tax cash flow remains the same and
the debt-to-equity ratio is higher.

Answer 2

Ans: C
Pre-tax cash flow stays the same because
depreciation (or amortization) is a non-cash
expense.
However, when the cost is expensed rather then
capitalized, net income and retained earnings are
lower, resulting in a lower equity. So the debt-to-
equity ratio will be higher.

Question 3

A company records an asset retirement
obligation (ARO) because of environmental
damage. Which of the following will most
likely result from the recording an ARO in any
given year?
A. An increase in return on equity and an
increase in depreciation expense
B. An decrease in return on equity and an
increase in depreciation expense
C. An decrease in return on equity and an
decrease in depreciation expense

Answer 3

Ans: B
Obligation associated with the retirement of
tangible fixed assets are referred to as asset
retirement obligations (AROs) and include costs for
cleaning up the operating site and restoring it to
pre-existing conditions, including rectifying any
environmental damages.
ARO accounting requires companies to record an
asset and a related liability for costs incurred to
remedy environmental damage. The asset increase
will result in an increase in depreciation expense
that will reduce net income. Lower net income will
reduce the company’s return on equity

Question 4

Impact of depreciation method on Financial statement
SL method

Answer 4

Dep. expense
Net income
assets
equity
ROA
ROE
Asset turnover
operating profit margin
current ratio
Debt/equity

Question 5

Impact of depreciation method on Financial statement
DDB method

Answer 5

Dep. expense
Net income
assets
equity
ROA
ROE
Asset turnover
operating profit margin
current ratio
Debt/equity

Question 6

Impact on Financial statement
Expensing

Answer 6

Equity
Earnings
Pre-tax cash generated
CFI
pre-tax cash flow
profit margin
asset turnover
current ratio
debt to equity
Roa
Roe

Question 7

Impact on Financial statement
Capitalizing

Answer 7

Equity
Earnings
Pre-tax cash generated
CFI
pre-tax cash flow
profit margin
asset turnover
current ratio
debt to equity
Roa
Roe

Question 8

Which of the following would most likely be
lower in the early years of an asset’s life using
accelerated depreciation methods rather than
straight-line depreciation?
A. Investing cash flow
B. Shareholder’s equity
C. Cash flow from operations

Answer 8

Ans: B
The greater depreciation expense in the early
years of an asset’s life using accelerated
depreciation methods rather than straight-line
depreciation would lead to lower net income and
lower retained earnings in those years. Lower
retained earnings would result in lower
shareholders’ equity.

Question 9

An analyst is comparing the financial
statements of Company A and Company B.
both companies have incurred expenses of
approximately $250 million in the current year
to expand their production facilities. Company
A is highly leveraged. Company B does not
have any outstanding debt and paid the $250
million from internal cash reserves. The most
likely effect of the difference in the capital
structures of the two companies will be:
A. Company A will report higher asset
balances related to the facilities under
construction.
B. The companies will report the same asset
balances related to the facilities under
construction.
C. Company A’s interest coverage ratio will be
lower than it would have been if the company
had expensed all interest.

Answer 9

Ans. A.
Since Company A is leveraged, it will be required
to capitalize the interest related to the
construction project even if there was no
borrowing specially for the $250 million (an
assumption is made that the money actually came
from some kind of borrowing, even if there is no
specific loan for the amount). Company B on the
other hand, will not have any interest to capitalize.
As a result, Company A’s balance sheet will reflect
an amount in excess of the $250 million for the
facilities under construction, while Company B will
reflect only the $250 million.

Question 10

guardare domanda 8

Question 11

During the early years of an asset’s life, a
company using an accelerated depreciation
method, rather than straight-line, could
expect a lower value for:
A. Asset turnover.
B. Shareholders’ equity.
C. Asset turnover and shareholders’ equity.

Answer 11

Ans: B.
Shareholders’ equity would be less during the
early years of the asset’s expected life because
depreciation expense is higher, net income is
lower, and retained earnings is lower. Asset
turnover (sales/assets) is greater during the early
years because accelerated depreciation increase
accumulated depreciation at a faster rate than
doer straight-line, thus reducing assets and
increasing asset turnover.

Question 12

A company has announced that it is going
to distribute a group of long-lived assets to its
owners in a spin-off. The most appropriate
way to account for the assets until the
distribution occurs is to classify them as:
A. held for sale with no depreciation taken.
B. held for use until disposal with no
deprecation taken.
C. held for use until disposal with depreciation
continuing to be taken.

Answer 12

Ans. C.
Long-lived assets that will be disposed of other
than by sale, such as a spin-off, an exchange for
other assets, or abandonment, are classified as
held for use until disposal and continue to be
depreciated until that time.

Question 13

At the start of the year, a company
acquired new equipment at a cost of €50,000,
estimated to have a 3 year life and a residual
value of €5,000. If the company depreciates
the asset using the double declining balance
method, the depreciation expense that the
company will report for the third year is
closest to:
A. €555.
B. €3,328.
C. €3,705.

Answer 13

Ans: A
Depreciation cannot be 2/3 x 5,555 = 3,705
since that would reduce book value to below
the estimated 5,000

Question 14

anche nell’units of production tieni conto del residual value

Question 15

A company, which prepares its financial
statements in accordance with IFRS uses the
revaluation model to value land. At the end of
the current year the land value of the land has
increased and will be adjusted on the balance
sheet. Which of the following statements is
most accurate? In the current period the
revaluation of the land will:
A. increase return on sales.
B. increase return on assets.
C. decrease the debt to equity ratio.

Answer 15

Ans: C.
The increase in the value of the land bypasses the
income statement and goes directly to a
revaluation surplus account in equity. Equity
increases thereby decreasing the debt to equity
ratio.

Question 16

16. Which of the following is the least likely
    reason as to why a firm’s management would
    increase the value of a capital asset that had
    been previously written down?
    A. Management wants to increase ROE in
    future periods.
    B. The company is approaching the leverage
    limits of its borrowing agreement.
    C. Management is concerned that income for
    the current year will fall below levels expected
    by analysts.

Answer 16

Ans: A.
The increase in an asset’s value would increase
depreciation expense and therefore decrease ROE
in future periods, not increase it. An asset
revaluation that reverses a previous downward
revaluation is reported in net income in the period
it is revalued. Hence management can use upward
revaluations to increase net income (and hence
meet the analysts’ expectations). This one-time
increase in net income would increase ROE for the
current year only.

Question 17

Two software companies that report their
financial statements under U.S. GAAP
(generally accepted accounting principles) are
identical except as to how soon they judge a
project to be technologically feasible. One firm
does so very early in the development cycle
while the other usually waits until just before
the project is released to manufacturing.
Compared to the company that judges
technological feasibility early, the one that
waits until closer to manufacturing will most
likely report lower:
A. financial leverage.
B. total asset turnover.
C. cash flow from operations.

Answer 17

Ans: C.
U.S. GAAP requires that a company expense costs
related to software development until product
feasibility is established and capitalize any costs
thereafter. The company that capitalizes these
software development costs reports the
expenditures in the investing activities section of
the statement of cash flows; the company that
expenses software development costs reports the
expenditures in the cash flow from operations.

Question 18

A company acquires some new
depreciable assets. Which of the following
combinations of estimated salvage value and
useful life will most likely produce the highest
net profit margin?
A. low salvage value estimates and long
average lives.
B. high salvage value estimates and long
average lives.
C. high salvage value estimates and short
average lives.

Answer 18

Ans: B.
A high salvage value estimate reduces the
depreciable base and thus depreciation expense;
long average lives reduce the annual depreciation
expense for any givendepreciable base. The
combination of the two would result in the lowest
depreciation expense which leads to the highest
net income and profit margins.

Question 19

guardare domanda 25-26

Question 20

guardare domanda 28

Question 21

The capitalization of interest (versus
expensing) will have which of the following
effects on a company’s financial ratios?
A. Lower interest coverage ratio.
B. Lower debt-to-equity ratio.
C. Higher asset turnover ratio.

Answer 21

Ans: B.
The capitalization of interest will increase
shareholders’ equity, resulting in a lower debt-to-
equity ratio.
A is incorrect. Since interest expense
(denominator) will be lower when interest is
capitalized, the interest coverage ratio will be
higher, not lower.
C is incorrect. The capitalization of interest will
result in a larger asset base and a lower asset
turnover ratio (sales/ average assets).

Question 22

Bao Incorporated recently paid more than
the net book value to acquire Cleanway
Corporation. Cleanway operates an active
research and development program into
environmentally friendly cleaning products.
Bao is very interested in this research
program as well as the good management
team in place at Cleanway. The excess price
paid over the net book value of the assets
should be accounted for on Bao’s financial
statements as:
A. goodwill.
B. a trademark.
D. an intangible asset, research and
development.

Answer 22

Ans: A.
The excess price paid over the net book value
during an acquisition that cannot be assigned to
other identifiable assets is assumed to be for
goodwill. Goodwill is said to be an unidentifiable
asset that cannot be separated from the business
itself.

Question 23

Two companies are identical except for
their accounting treatment of research and
development costs. On e company expenses
all such costs immediately, while the other
company capitalizes a portion of the costs.
Compared to the company that capitalizes
costs, the company that expenses
immediately will most likely:
A. earn a lower ROA.
B. have a lower financial leverage.
C. report lower cash flow from operations in
the statement of cash flows.

Answer 23

Ans: C.
Companies that capitalize research and
development costs report those expenditures in
the investing activities section of the statement of
cash flows; companies that expense research and
development costs report those expenditures in
cash flow from operations.

Question 24

In the period when a firm makes an
expenditure, capitalizing the expenditure
instead of recognizing it as an expense will
result in higher:
A. debt-to-equity and debt-to-assets ratios.
B. net income and have no effect on total cash
flows.
C. cash flow from investing and lower cash
flow from operations.

Answer 24

Ans: B.
Net income is higher with capitalization because it
does not decrease by the full amount spent, as it
would with expensing. Capitalizing expenditure
changes its cash flow classification from an
operating cash outflow to an investing cash
outflow. As a result, CFO is higher and CFI is lower
than they would be if the expenditure had been
immediately expensed. Total cash flow, however, is
unaffected (assuming the tax treatment of the
expenditure is independent of the financial
reporting treatment). Equity is higher in the period
of the expenditure with capital capitalization.
Assets are higher because they include the
capitalized asset. Debt is unaffected by the
decision to capitalize or expense. Thus, the debt-
to-equity and debt-to-assets ratios are lower with
capitalization.

Question 25

In the early years of an asset’s life, a firm
that chooses an accelerated depreciation
method instead of using straight-line
depreciation will tend to have:
A. lower net income and lower equity.
B. higher return on equity and higher return
on assets.
C. lower depreciation expense and lower
turnover ratios.

Answer 25

Ans: A.
These relationships are reversed in the later years
of the asset’s life if the firm’s capital expenditures
decline.

Question 26

A manufacturing firm shuts down
production at one of its plants and offers the
facility for rent. Based on the market for
similar properties, the firm determines that
the fair value of the plant is €500,000 more
than its original cost. If this firm uses the cost
model for plant and equipment and the fair
value model for investment property, should it
recognize a gain on its income statement
under IFRS?
A. Yes, because the plant will be reclassified
as investment property.
B. No, because the increase in value does not
reverse a previously recognized loss.
C. No, because the firm must continue to use
the cost model for valuation of this asset.

Answer 26

Ans: B.
According to IFRS, property held for the purpose
of earning rental income is classified as investment
property. However, when a property is transferred
from owner-occupied to investment property, a
firm using the fair value model must treat any
increase in the property’s value as a revaluation.
That is, the firm may only recognize a gain on the
income statement to the extent that it reverses a
previously recognized loss.

Question 27

Under U.S.GAAP, an asset is considered
impaired if its book value is:
A. less than its market value.
B. greater than the present value of its
expected future cash flows.
C. greater than the sum of its undiscounted
expected cash flows.

Answer 27

Ans: C.
Under U.S.GAAP, an asset is considered impaired
when its book values is greater than the sum of
the estimated undiscounted future cash flows from
its use and disposal

Question 28

Bao Inc. owns a machine with a carrying
value of $3.0 million and a salvage value of
$2.0 million. The present value of the
machine’s future cash flows is $1.7 million.
The asset is permanently impaired. Bao
should (under IFRS):
A. immediately write down the machine to its
salvage value.
B. immediately write down the machine to its
recoverable amount.
C. write down the machine to its recoverable
amount as soon as it is depreciated down to
salvage value.

Answer 28

Ans: B.
Under IFRS, when an asset is permanently
impaired, it must be written down to its
recoverable amount (greater of value in use or fair
value less selling costs) in the period in which the
impairment is recognized.

Question 29

Bao Company has revalued an intangible
asset with an indefinite life upward by €25
million. In its financial statements, Bao will
most likely:
A. disclose how it determined the fair value of
the intangible asset.
B. report lower net income in subsequent
periods because of increased amortization
expense on the asset.
C. report higher assets, net income, and
shareholders’ equity in the most recent period
than it would have reported under the cost
model.

Answer 29

Ans: A.
For firms that revalue assets upward, IFRS
requires disclosure of the date the asset was
revalued, how management determined its fair
value, the asset’s carrying value using the
historical cast model, and (for intangible assets)
whether the asset’s useful life is finite or indefinite.
Although assets and shareholders’ equity will
increase as a result of the revaluation, net income
will not increase. The increase in the value of the
asset is reported as a revaluation surplus in
shareholders’ equity. Amortization expense will not
increase because indefinite-lived intangible assets
are not amortized.

Question 30

Which of the following statements about
the role of depreciable lives and salvage
values in the computation of depreciation
expenses for financial reporting is least
accurate?
A. Estimates of the useful life of the same
depreciable asset can differ between
companies.
B. Companies are required to disclose data
about estimated salvage values in the
footnotes to the financial statements.
C. Depreciable lives and salvage values are
chosen by management and allow for the
possibility of income manipulation.

Answer 30

Ans: B.
Companies typically do not disclose data about
estimated salvage values, except when estimates
are changed

Question 31

A reconciliation of beginning and ending
carrying values for long-lived tangible assets
is required for firms reporting under:
A. IFRS.
B. U.S.GAAP.
C. both U.S.GAAP and IFRS

Answer 31

Ans: A.
The required disclosures for long-lived assets
under IFRS are more extensive than they are
under U.S.GAAP. IFRS requires a reconciliation of
beginning and ending carrying values for classes of
long-lived tangible assets, while U.S.GAAP does
not.

Question 32

Two growing firms are identical except
that A Company capitalizes costs for some
long-lived assets that C Company expenses.
For these two firms, which of the following
financial statements effects is most likely? A
Company will show higher:
A. net income than C Company.
B. working capital than C Company.
C. investing cash flow than C Company.

Answer 32

Ans: A.
For growing firms, capitalizing results in higher net
income compared to expensing. A capitalizing
company classifies the costs of the capitalized
assets as CFI outflows, while a company that
expenses these costs classifies them as CFO
outflows. Thus, A Company’s CFO will be higher
and CFI than C Company’s working capital is
unaffected by the decision to capitalize or expense
because the decision does not affect current assets
or current liabilities.

Question 33

Harding Corp. has a permanently impaired
asset. The difference between its carrying
value and the present value of its expected
cash flow should be written down immediately
and:
A. reported as an operating loss.
B. charged directly against retained earnings.
C. reported as non-operating loss in other
comprehensive income

Answer 33

Ans: A.
Impairment writedowns are reported losses “above
the line” and are included in income from
continuing operations.

Question 34

A company that capitalizes costs instead
of expensing them will have:
A. higher income variability and higher cash
flows from operations.
B. lower cash flows from investing and lower
income variability.
C. lower cash flows from operations and
higher profitability in early years.

Answer 34

Ans: B.
Capitalizing costs tends to smooth earnings and
reduces investment cash flows. It will also increase
cash flows from operating and increase profitability
in the early years.

Question 35

East Company incurs $110,000 of costs to
establish technological feasibility of a new
software application it hopes to sell and
$90,000 of costs to develop the application.
West Company incurs $110,000 of research
costs related to a new product and $90,000 of
development costs for the product. If East
reports under U.S.GAAP and West reports
under IFRS, these projects will:
A. increase East’s total assets more the West’s
total assets.
B. increase West’s total assets more the
West’s total assets.
C. have the same effects on East’s and West’s
total assets

Answer 35

Ans: C.
Under U.S.GAAP, costs incurred to establish
technological feasibility has been established must
be capitalized. Under IFRS, research costs are
expensed as incurred and development costs are
capitalized. Thus, both East and West will
capitalize $90,000 of development costs.

Question 36

A company takes a $10 million impairment
charge on a depreciable asset in 2011. The
most likely effect will be to:
A. increase reported net income in 2012.
B. decrease net income and taxes payable in
2011.
C. increase return on equity and operating
cash flow in 2012.

Answer 36

Ans: A.
The impairment write-down in 2011 will reduce
depreciation expense in 2012, which will increase
2012 EBIT and net income. Operating cash flow
and taxes payable are not affected because an
impairment cannot be deducted from income for
tax reporting purposes until the asset is sold or
otherwise disposed of