liabilities (schweser exam q) understand, statements, Stock, which, would

sabina

I don't understand, how is the franchise capitalized, and amortized, but the franchise is not counted as debt. Does anyone know why is the franchise not counted as debt (which would presumably add $10m - $2m amortization)?



Selected information from Yorktown Corp.’s financial statements for the year ended December 31, 2004 was as follows (in $ millions):

Accounts Payable
8

Long-term Debt
9

Common Stock
17

Retained Earnings
23

Total Liabilities & Equity
57


In 2004, Yorktown paid $10 million cash to purchase a franchise. The franchise cost was fully expensed in 2004. If the company had elected to amortize the franchise cost over 5 years instead of expensing it, Yorktown’s total debt ratio (total debt-to-total capital) would:


A) increase from 0.474 to 0.551.

B) decrease from 0.298 to 0.262.

C) decrease from 0.474 to 0.403.


Your answer: C was incorrect. The correct answer was B) decrease from 0.298 to 0.262.

Total capital equals total assets which must equal total liabilities and equity. Yorktown’s total debt ratio was (($8 + $9) / $57 =) 0.298. If the franchise cost were amortized, retained earnings would be increased $8 million ($10 cost less ($10 / 5 =) $2 million of amortization.) The total debt ratio would change to (($8 + $9) / ($57 + $8) =) 0.262.

bluejazzy

capitalise means that an expense becomes an asset and amortised/depreciated over time, an example of this would be rent, paid, but recorded as prepaid expense (an asset) and used over time.



Edited 1 time(s). Last edit at Wednesday, April 28, 2010 at 12:54AM by lzen5.

Penny-wenny

In addition only B) makes sense - by elimination - in the first place the ratio was 0.298.