Section 1 - Depreciation on the Financial Statements vs. Tax Return

Question 1

When a _____ is performed, the CPA does not express an opinion on the reliability of the statements and whether they conform to GAAP.

Answer 1

Compilation.

When a compilation is performed, the independent CPA organizes the companies financial data and prepares the financial statements following the industry format. A compilation is nothing more compiling the data, there is no inspection of the statements as the CPA’s job scope does not go beyond organizing the financial data.

Question 2

The matching principle requires:

Answer 2

The matching principle requires requires that revenues earned in an accounting period be matched with related expenses.

Question 3

The ‘fixed’ in fixed assets means

Answer 3

The word fixed in fixed asset means the asset will not be used up, consumed or sold within one year or accounting period and does not mean the item cannot be moved.

Question 4

Fixed assets, are those that

Answer 4

Fixed assets, also referred to as Property (land), Plant (buildings) and Equipment (machine and trucks) are considered long-term assets and provide benefits to the company for more than one year, or accounting cycle.

Question 5

Fixed assets are also referred to as

Answer 5

Property (land), Plant (buildings) and Equipment (machine and trucks)

Question 6

When does a CPA performing a review or audit not have to make sure that the tax depreciation expense is the same amount recorded for GAAP depreciation?

Answer 6

If the difference between the two is immaterial, it can be ignored.

For example, if a company has book depreciation of $33,000 and tax depreciation is 29,000, so long as the CPA deems that the $4,000 is not material, depreciation can be presented on the reviewed or audited financial statements as $29,000.

Question 7

Accumulated depreciation is used to determine an asset’s net book value.

True or False

Answer 7

True.

Net book value is found using the accumulated depreciation account balance as follows:

Original Cost

- Accumulated Depreciation

- Impairment charges (if any)

Net book value

Question 8

GAAP depreciation rules are required when

Answer 8

GAAP depreciation rules are required when a company’s financial statements are prepared for use by third parties.

Example: Used to obtain a bank loan, potential investors, or company looking to acquire.

Question 9

Many of the tax depreciation rules are based on the same concepts as GAAP depreciation rules.

True or False

Answer 9

True.

Question 10

Depreciation must be recorded on a yearly basis regardless of whether the company follows a calendar or fiscal year.

True or False.

Answer 10

True.

Question 11

All publicly traded companies must use GAAP for the preparation of their financial statements.

True or False

Answer 11

True.

Question 12

The materiality concept varies based on the size of the entity and often based on the net impact on

Answer 12

Materiality is generally based on the impact on reported profits, or the percentage or dollar change in a specific line item in the financial statements.

Question 13

Intangible assets are

Answer 13

Intangible assets are those things of value that a company owns that cannot be physically seen or touched.

Examples of Intangible assets include: Goodwill, patents, and copyrights are an example of intangible assets.

Question 14

When an audit is performed, the independent CPA examines the company’s financial statements and expresses an opinion on whether the financial statements ________ conform to GAAP rules.

Answer 14

Materially.

Materiality is an accounting concept that sets a threshold for which missing or incorrect information in the financial statements is substantial enough to affect the judgment and decision making of users.

Question 15

The general entry to record depreciation expense is:

Answer 15

Depreciation Expense (DR.)

Accumulated Depreciation (CR.)

The debit to depreciation expense increases the Depreciation expense balance and the credit to the contra-asset account Accumulated Depreciation increases the balance.

Question 16

For companies subject to GAAP, depreciation is computed twice.

True or False

Answer 16

True.

For companies subject to GAAP, depreciation is computed twice; once under GAAP for their financial statements and once under the IRS rules for the preparation of their federal tax return.

Question 17

Fixed assets are purchased with the intent of immediate resale.

True or False

Answer 17

False.

Fixed assets are not purchased with the intent of immediate resale, but instead for productive use within the company for more than one year.

Question 18

The fundamental difference between GAAP and IRS depreciation is?

Answer 18

The fundamental difference is how the depreciation is calculated. For one, the IRS requires companies to use the MACRS tables which specifies the assets recovery period (useful life) and assumes that there is no residual value as compared to GAAP which allows companies to choose one of four methods, Straight-line, units of production, declining balance method and the sum of the year’s digits, allows management to estimate the useful life, as well as estimate the asset’s residual value.

Question 19

Depreciation is governed by which GAAP principle?

Answer 19

Matching principle

Question 20

Current assets are those that will be

Answer 20

Current assets are those that will be used up or converted into cash within a year or one accounting cycle, whichever is longer.

Question 21

When an audit is performed, the independent CPA examines the company’s financial statements and expresses an opinion on whether the financial statements materially conform to GAAP rules.

True or False

Answer 21

True.

Question 22

With MACRS, all assets are depreciated to zero and assume there is no residual or “salvage” value associated with the asset.

Answer 22

True.

As compared to the GAAP depreciation rules which allow companies to estimate the useful life and residual value, the IRS rules which require MACRS assumes that assets have no residual value, therefore, all assets are depreciated to zero.

Question 23

A CPA’s preparation of a company’s income tax return is considered involvement with the financial statements

True or False

Answer 23

False.

A CPA’s preparation of a company’s income tax return is not considered involvement with the financial statements and, much like a compilation, does not require the CPA to use GAAP depreciation rules

Question 24

Which methods are allowed under GAAP depreciation?

Answer 24

GAAP allows companies to choose one of four methods:

1. Straight-line
2. Units of production
3. Declining balance method (125%, 150%, 200%)
4. Sum-of-the-years digits.

Question 25

If a company has book depreciation of $23,000 and tax depreciation is 19,000, so long as the CPA deems that the $4,000 is not material, depreciation can be presented on the reviewed or audited financial statements as $19,000.

True or False

Answer 25

True.

So long as the $4,00 difference in the financial statements is not substantial enough to affect the judgment and decision making of users, the company is allowed to use the same amount for both book and tax purposes.

Question 26

When an audit is performed, the independent CPA provides a report describing his or her findings after performing a limited inspection of the financial statements and stating whether her or she found any material differences from the GAAP rules.

True or False.

Answer 26

False

When a review is performed, the independent CPA provides a report describing his or her findings after performing a limited inspection of the financial statements and stating whether her or she found any material differences from the GAAP rules. When an audit is performed, the independent CPA examines the company’s financial statements and expresses an opinion on whether the financial statements materially conform to GAAP rules.

Question 27

Depreciation is defined as

Answer 27

Depreciation is defined as a system for allocating or spreading the cost of ‘fixed assets’ over their estimated useful life in a rational and systematic manner.

Question 28

Depreciation Expense is an income statement account.

True or False

Answer 28

True.

Question 29

A company that prepare their financial statements for third parties under GAAP can have an independent CPA perform one of the following three services

Answer 29

1. Compilation
2. Review
3. Audit

Question 30

Depreciation is an example of an accrual.

True or False

Answer 30

False.

Although made at the end of the period with other adjusting entries, depreciation is not an accrual or deferral, but simply one of the other end of period adjustments.

Question 31

Depreciation is the reduction in value of an asset with the passage of time, mainly due to ______

Answer 31

Wear and tear.

Question 32

The difference between the GAAP and IRS calculations is often not materially different.

True or False

Answer 32

True.

Many of the tax depreciation rules are based on the same concepts as GAAP depreciation rules.

Question 33

The Depreciation Expense account appears on which financial statement?

Answer 33

Depreciation Expense is an income statement (temporary) account.

Question 34

When depreciation is computed for tax purposes, it is recorded in the books, and on the tax return as a deduction.

True or False

Answer 34

False.

Depreciation for the IRS purposes is not recorded in the books and only appears as a deduction on the company’s tax return.

Question 35

How is net book value calculated?

Answer 35

Original cost

• Accumulated depreciation

- Impairment charges (if any)

Net Book Value

Question 36

When companies purchase fixed assets, the cost of the asset is

Answer 36

When companies purchase fixed assets, the cost of the asset is spread over the years the machine helps produce and generate revenue, which is governed by GAAP’s matching principle.

Question 37

Accumulated Depreciation is a contra-asset balance sheet account.

True or False

Answer 37

True.

Question 38

The IRS requires companies to use the ______ tables,

Answer 38

MACRS - Modified Accelerated Cost Recovery System

Question 39

Most small companies are permitted to use the IRS depreciation rules for both their tax return and financial statements.

True or False

Answer 39

True.

Assuming the small company will not issue their financial statements to third parties and do not need an audit, they are allowed to use the IRS depreciation rules for both book and tax return purposes.

Question 40

MACRS stands for

Answer 40

Modified Accelerated Cost Recovery System

Question 41

When a compilation is performed, the independent CPA organizes the companies financial data and prepares the financial statements following the industry format.

True or False

Answer 41

True.

When a compilation is performed, there is no inspection of the statements as the CPA’s job scope does not go beyond organizing the financial data. In essence, when a company hires a CPA for a compilation, their primary function is to prepare the financials using whatever facts and figures were provided by the company. A CPA does not express an opinion on the reliability of the statements and whether they conform to GAAP.

Question 42

When a ____ is performed, there is a limited inspection of the financial statements.

Answer 42

Review.

When a review is performed, the independent CPA provides a report describing his or her findings after performing a limited inspection of the financial statements and stating whether her or she found any material differences from the GAAP rules.

Question 43

How is depreciation calculated under MACRS?

Answer 43

Under IRS rules, the depreciation calculation is based on a staggered formula, where specific asset classes have a designated a lifespan, and each year a certain percentage of depreciation allowance is assigned to each year, as given in MACRS depreciation tables.

Question 44

There are two sets of depreciation rules companies must follow.

True or False

Answer 44

True.

There are two sets of depreciation rules companies must follow; one governed by the Internal Revenue Service (IRS), which must be used to compute depreciation for the tax return and rules under Generally Accepted Accounting Principles (GAAP) which must be used to compute depreciation for the Financial Statements.

Question 45

The balance in the Accumulated Depreciation account represents

Answer 45

The balance in the Accumulated Depreciation account reflects the total depreciation expense recognized since the asset has been placed in service.

Question 46

Accumulated Depreciation is a contra-asset balance sheet account and increases the balance in the associated asset account.

True or False

Answer 46

False

When depreciation is recognized, and an amount is credited to the Accumulated Depreciation account, this increases the balance in the account and since it is a contra-asset account, the credit balance offsets (reduces) the balance in the associated asset account. For example, if there is an asset on the books with an original cost of $500, if the balance in the Accumulated Depreciation account is $200, the net book value of the asset is $300. As depreciation is recognized, the balance in Accumulated Depreciation is increased, further decreasing the net book value.

Question 47

Companies are allowed to record their depreciation monthly as opposed to at the end of the year.

True or False.

Answer 47

True.

At minimum, companies are required to record annual depreciation, however some companies may choose to record depreciation more frequently, and may recognize the expense monthly or quarterly.

Question 48

The purpose of spreading the cost of an asset over several years is to:

Answer 48

The purpose of spreading the cost of an asset over several years is to match the cost of the asset with the revenue it helps to produce and generate each year and is mandatory under the ‘matching principle’

Question 49

Fixed assets appear in the financial statements and are recorded in the books at net book value.

True or False

Answer 49

True

Fixed assets appear in the financial statements and are recorded in the books at its net book value, which is its original cost, minus accumulated depreciation, minus impairment charges if any.

Question 50

What is materiality?

Answer 50

Materiality is an accounting concept that sets a threshold for which missing or incorrect information in the financial statements is substantial enough to affect the judgment and decision making of users.