Financial Statement Analysis II

Question 1

When certain expenditures result in tax credits that directly reduce taxes, the company will most likely record:

a deferred tax asset.
a deferred tax liability.
no deferred tax asset or liability.

Answer 1

C is correct. Tax credits that directly reduce taxes are a permanent difference, and permanent differences do not give rise to deferred tax.

Question 1

When accounting standards require recognition of an expense that is not permitted under tax laws, the result is a:

deferred tax liability.
temporary difference.
permanent difference.

Answer 1

C is correct. Accounting items that are not deductible for tax purposes will not be reversed and thus result in permanent differences.

Question 2

In early 2018, Sanborn Company must pay the tax authority EUR37,000 on the income it earned in 2017. This amount was most likely recorded on the company’s 31 December 2017 financial statements as:

taxes payable.
income tax expense.
a deferred tax liability.

Answer 2

A is correct. The taxes a company must pay in the immediate future are taxes payable.

Question 3

Using the straight-line method of depreciation for reporting purposes and accelerated depreciation for tax purposes would most likely result in a:

deferred tax asset.
valuation allowance.
temporary difference.

Answer 3

C is correct. Because the differences between tax and financial accounting will correct over time, the resulting deferred tax liability, for which the expense was charged to the income statement but the tax authority has not yet been paid, will be a temporary difference. A valuation allowance would only arise if there was doubt over the company’s ability to earn sufficient income in the future to require paying the tax.

Question 4

Income tax expense reported on a company’s income statement equals taxes payable, plus the net increase in:

deferred tax assets and deferred tax liabilities.

deferred tax assets, less the net increase in deferred tax liabilities.

deferred tax liabilities, less the net increase in deferred tax assets.

Answer 4

C is correct. Higher reported tax expense relative to taxes paid will increase the deferred tax liability, whereas lower reported tax expense relative to taxes paid increases the deferred tax asset.

Question 5

Analysts should treat deferred tax liabilities that are expected to reverse as:

equity.
liabilities.
neither liabilities nor equity.

Answer 5

B is correct. If the liability is expected to reverse (and thus require a cash tax payment) the deferred tax represents a future liability.

Question 6

When accounting standards require an asset to be expensed immediately but tax rules require the item to be capitalized and amortized, the company will most likely record:

a deferred tax asset.

a deferred tax liability.

no deferred tax asset or liability.

Answer 6

A is correct. The capitalization will result in an asset with a positive tax base and zero carrying value. The amortization means the difference is temporary. Because there is a temporary difference on an asset resulting in a higher tax base than carrying value, a deferred tax asset is created.

Question 7

A company incurs a capital expenditure that may be amortized over five years for accounting purposes, but over four years for tax purposes. The company will most likely record:

a deferred tax asset.

a deferred tax liability.

no deferred tax asset or liability.

Answer 7

B is correct. The difference is temporary, and the tax base will be lower (because of more rapid amortization) than the carrying value of the asset. The result will be a deferred tax liability.

Question 8

A company receives advance payments from customers that are immediately taxable but will not be recognized for accounting purposes until the company fulfills its obligation. The company will most likely record:

a deferred tax asset.

a deferred tax liability.

no deferred tax asset or liability

Answer 8

A is correct. The advances represent a liability for the company. The carrying value of the liability exceeds the tax base (which is now zero). A deferred tax asset arises when the carrying value of a liability exceeds its tax base.

Question 9

Which of the following isleast likelya criterion to recognize revenue under US GAAP?

A. Price is determinable.
B. There is evidence of an arrangement between the buyer and the seller.
C. Cash is received.

Answer 9

Answer: C
In order to recognize revenue, the seller should be reasonably sure of collecting money. Receipt of cash isnota requirement for revenue recognition under US GAAP or IFRS.

Question 10

Which of the following statements regarding the classification of cash flows is not true?

As per U.S. GAAP, interest received is classified as an investing activity.

As per IFRS, interest paid is classified as an operating or a financing activity.

As per U.S. GAAP, dividends paid is classified as a financing activity.

Answer 10

A is not true because As per U.S. GAAP, interest received is classified as an operating activity !

Question 11

Which of the following items is most likely subtracted from net income when using the indirect method to determine the cash flow from operating activities?

Amortization of intangible assets.

Increase in deferred income tax liability.

Amortization of bond premium.

Answer 11

Amortization of bond premium is a noncash income, and therefore it has to be deducted from net income to arrive at cash from operating activities.

Question 12

How would an acquisition of a building through only the issuance of shares of common stock be accounted for on the statement of cash flows?

CFI
CFF
Only in disclosures

Answer 12

Answer: C
No actual cash exchanges hands, so it would only be reported in disclosures

Question 13

Which of the following is not an issue that analysts should consider when examining inventory disclosures?

A. Amount of any write-downs recognized
B. Amount of reversal recognized on any previous write-down for a company using GAAP
C. Description of circumstances that led to a reversal for a company using IFRS

Answer 13

Answer: B
Reversals are only allowed under IFRS !

Question 14

Which of the following statements is most likely regarding the effects of capitalization on a company’s financial statements?

Capitalization reduces the company’s reported total asset turnover.

Capitalization increases the company’s reported debt-to-assets ratio.

Capitalization decreases the company’s outflows from investing activities.

Answer 14

Capitalization of an expense results in an increase in noncurrent assets, which leads to a decrease in the total asset turnover ratio (sales/assets) and the debt-to-assets ratio (debt/assets).

Capitalization results in a decrease in CFI or an increase in outflows from investing activities.

Question 15

Which of the following best shows the financial effect on net income, and operating cash flows respectively, on subsequent years of deciding to capitalize the cost rather than expensing it?

Lower, higher

Higher, lower

Lower, lower

Answer 15

The first choice is correct. Firms that capitalize costs recognizes the depreciation in subsequent years. Its net income will be lower than those that expense the cost. Since net income is lower, the entity will pay less taxes thus increasing cash flow from operations during subsequent years

Question 16

Which of the following types of intangible assets would be expensed?

Acquired through business combination

Acquired through means other than a business
combination

Developed internally

Answer 16

Answer: C
Only intangible assets developed internally would be expensed.

Question 17

The cost of which of the following assets isleast likelyexpensed over time?

A. Intangible assets with a definite useful life
B. Land acquired with the intent to construct a factory on it
C. Machinery with a useful life of 5 years

Answer 17

Answer: B
Land is anondepreciableasset.

Intangible assets with a definite useful life areamortizedover time.

Machinery with a useful life of more than 1 year isdepreciatedover its useful life.

Question 18

Which of the following is least accurate about the treatment of assets under IFRS and U.S. GAAP?

Revaluation is allowed under IFRS, but not under U.S. GAAP.

Impairment losses can be recovered under IFRS, but not under U.S. GAAP.

Research costs are capitalized under IFRS, but under U.S. GAAP they are expensed.

Answer 18

Under IFRS, research costs are expensed and development costs are capitalized. Under U.S. GAAP, both research and development costs are expensed.

Question 19

In 2014, TD Systems pays a fine of $10,000,000 for violations of national air pollution standards. Because of this, compared to the statutory tax rate, TD Systems’ effective tax rate is most likely:

Lower
The same
Higher

Answer 19

Answer: C

Because fines are generally not tax deductible, the fine will have the effect of lowering income before taxes on their income statement while not lowering taxable income on their income tax return. The lower income before taxes will result in a higher effective tax rate.

Question 20

Differences between the effective tax rate and the statutory rate arise due to all of the following EXCEPT:

A)deductible expenses.
B)non-deductible expenses.
C)tax credits.

Answer 20

A)deductible expenses.

Permanent tax differences such as tax credits, non-deductible expenses, and tax differences between capital gains and operating income give rise to differences in the effective and statutory tax rates.