on and off balance sheet Flashcards
Flashcard 1: PP&E Capitalization
Q: What happens when PP&E is acquired?
A: It is recorded at cost on the balance sheet (capitalization), and expenditures for PP&E are called CAPEX.
Flashcard 2: PP&E Depreciation
Q: How is the cost of PP&E recognized over time?
A: Through depreciation, which allocates the asset’s cost over its useful life as an expense on the income statement.
Flashcard 3: Depreciation Estimates
Q: What three estimates are required to determine depreciation expense?
A:
Useful life – Expected period of benefits.
Salvage value – Expected residual value.
Depreciation method – Pattern of asset usage.
Flashcard 4: Depreciation Policy Comparison
Q: Why do companies change depreciation policies?
A: Extending useful life assumptions (e.g., Intel’s revision in 2015) reduces depreciation expense, boosting profitability.
Flashcard 5: PP&E Turnover
Q: Why is higher PP&E turnover generally preferable?
A: Indicates lower capital investment relative to sales, enhancing profitability.
Flashcard 6: Risks of Low PP&E Turnover
Q: When might lower PP&E turnover be strategic?
A: Managers may invest heavily in PP&E, increasing operating leverage but reducing short-term turnover.
Flashcard 7: PPE Percent Used Up
Q: What does PPE Percent Used Up measure?
A: The proportion of depreciable assets that have already been transferred to the income statement.
Flashcard 8: Inventory Accounting
Q: What happens when inventory is sold?
A: Its cost is transferred from the balance sheet to the income statement as Cost of Goods Sold (COGS).
Flashcard 9: FIFO vs. LIFO Impact
Q: How do FIFO and LIFO impact gross profit?
A:
FIFO: Lower COGS, higher gross profit.
LIFO: Higher COGS, lower gross profit.
(In a rising inventory cost environment)
Flashcard 10: Lower of Cost or Market (LCM) Rule
Q: What does the LCM rule require?
A: Firms must write down inventory if market value falls below recorded cost.
Flashcard 11: Inventory Write-Downs
Q: How does an inventory write-down impact financials?
A:
Reduces inventory on the balance sheet.
Increases expense on the income statement.
Flashcard 12: Inventory Turnover
Q: Why is lower or declining Days Inventory Outstanding (DIO) generally preferred?
A: Suggests inventory is being sold efficiently, reducing carrying costs.
Flashcard 13: Factors Affecting Inventory Turnover
Q: What factors should be considered alongside DIO?
A:
Product mix (high-margin items sell slower).
Promotional policies.
Manufacturing efficiency.
Flashcard 14: Shift in Expense Classification
Q: How might firms manipulate expenses?
A: By shifting costs between COGS and SG&A to manipulate financial metrics.
Flashcard 16: Economics of Leasing
Q: What is the key factor in lease accounting?
A: Whether the lessee assumes economic benefits/risks.
Flashcard 17: Previous Lease Accounting Standards
Q: How were operating leases previously treated?
A:
Rent expense recorded in each period.
No liability recognized on the balance sheet.
Flashcard 18: Capital Lease Accounting
Q: How were capital leases previously accounted for?
A:
Lease asset and liability recorded at present value.
Interest and depreciation recognized over time.
Flashcard 19: New Leasing Standards (2019)
Q: What changes did the new leasing standards introduce?
A:
Renamed “capital leases” to “finance leases.”
Leases over 12 months must be capitalized.
No bright-line tests; principle-based determination.
Flashcard 20: Balance Sheet Impact of New Lease Standard
Q: How do the new lease standards impact balance sheets?
A: Operating leases now appear as liabilities, similar to finance leases.
Flashcard 21: Income Statement Treatment Under New Standards
Q: How do finance and operating leases differ?
A:
Finance leases: Depreciation + interest expense.
Operating leases: Single lease expense.
Flashcard 22: Cash Flow Impact of New Leasing Standard
Q: How does the new standard impact cash flow statements?
A:
Finance leases: Principal repayment in financing, interest in operating.
Operating leases: Entire lease payment in operating cash flow.
Flashcard 23: Chamber of Commerce Study on Lease Standard Impact
Q: What concerns did the U.S. Chamber of Commerce raise?
A:
Increased liabilities for U.S. firms ($1.5T).
Increased costs ($10.2B annually).
Potential job losses (190,000 jobs).
Flashcard 24: Criticism of the Chamber of Commerce Study
Q: What flaws were identified in the CoC report?
A:
Confuses reported liabilities with real obligations.
Assumes analysts use reported numbers uncritically.
Ignores that credit agencies already adjust for lease obligations.
Flashcard 25: Rationale for New Leasing Standard
Q: Why was the leasing standard changed?
A: To enhance transparency and prevent off-balance-sheet financing manipulation.
Flashcard 27: Key Takeaways
Q: What are the key insights from this module?
PP&E: Depreciation policies affect reported earnings.
Inventory: Costing methods and LCM rules impact COGS.
Leasing: New standards improve transparency but change financial metrics.
These flashcards provide a comprehensive understanding of PP&E, inventory accounting, and lease transactions under both old and new accounting standards.
