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11.  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.

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.

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12. A company recently purchased a warehouse property and related equipment (shelving, forklifts, etc.) for €50 million, which were valued by an appraiser as follows: Land €10 million, building €35 million, and equipment €5 million. The company incurred the following additional costs in getting the warehouse ready to use: ? €2.0 million for repairs to the building’s roof and windows ? €0.5 million to modify the interior layout to meet their needs (moving walls and doors, inserting and removing partitions, etc.) ? €0.1 million on an orientation and training session for employees to familiarize them with the facility The cost to be capitalized to the building account (in millions) for accounting purposes is closest to: A. €37.0. B. €37.5. C. €38.5.

Ans: B. The capitalized cost of the building would include the other costs that are directly attributable to the building and are involved in extending its life or getting it ready to use: Initial cost €35.00 Repairs to roof and windows 2.00 Modifications to interiors 0.50 Total cost €37.5 million

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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.

Ans: A. Under double declining balance method, the depreciation rate would be 2 x the straight line rate of 33.3%, i.e., 66.6%, or 2/3 depreciation rate per year. However, the asset should not be depreciated below its assumed residual value in any year. Double Declining Method of Depreciation Year Net BV at Start of Year Depreciation Net BV at End of Year 1 50,000 33,333 16,667 2 16,667 11,111 5,555 3 5,555 * 555 ** 5,000 * Alternative calculation for start of Year 3 Net Book Value: 50,000 x (1-0.667) x (1-0.667) = 5,555 ** Depreciation cannot be 2/3 x 5,555 = 3,705 since that would reduce book value to below the estimated 5,000

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14. A Mexican corporation is computing the depreciation expense of a piece of manufacturing equipment for the fiscal year ended December 31, 2010 using the information below. The company takes a full year’s depreciation in the year of acquisition. Date of purchase January 1, 2010 Cost of equipment MXN 2,000,000 Estimated residual value MXN 200,000 Expected useful life 10 years Total productive capacity 5,000,000 units Production in 2010 800,000 units The depreciation expense (in MXN) will most likely be: A. 180,000 lower using the straight-line method compared with the double-declining balance method. B. 140,000 higher using the units-of-production method compared with the straight-line method. C. 112,000 higher using the double-declining method compared with the units-of-production method.

Ans: C.          The difference between the double declining balance and units-of-production is: 400,000 – 288,000 = 112,000. Straight-line Units of Production Declining balance Rate 1/10 5,000,000 units 1/10 x 2 = 20% Annual expense 2,000,000 – 200,000 10 (2,000,000 – 200,000) x (800,000/5,000,000) 0.20 x 2,000,000 = 180,000 = 288,000 = 400,000 Difference between the declining balance and units of production is: = 400,000 – 288,000 = 112,000

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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.

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. A is incorrect. Return on sales= The increase in the value of the land bypasses the income statement and goes directly to a revaluation surplus account in equity. It doesn’t affect net income or sales. So the return on sales stays the same. B is incorrect. Return on asset= The increase in the value of the land increases asset, while the net income stays the same. So it decreases the return on asset.

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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.

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.

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17. A Canadian printing company which prepares its financial statements according to IFRS has experienced a decline in the demand for its products. The following information relates to the company’s printing equipment as of 31 December 2010. C$ Carrying value of equipment (net book value) 500,000 Undiscounted expected future cash flows 550,000 Present value of expected future cash flows 450,000 Fair Value 480,000 Costs to sell 50,000 Value in use 440,000 The impairment loss (in C$) is closest to: A. 0. B. 60,000. C. 70,000.

Abs: B. Under IFRS, an asset is considered to be impaired when its carrying amount exceeds its recoverable amount (the higher of fair value less cost to sell or value in use). Fair value less costs to sell: 480,000 – 50,000 = 430,000 Value in use = 440,000 Recoverable amount (higher value) = 440,000 Impairment loss under IFRS = Carrying value – recoverable amount = 500,000 – 440,000 = 60,000 Note: impairment of long-lived tangible assets held for use An impairment loss is recognized when the carrying (book) value of the tangible of the asset exceeds its fair value and the carrying value is not recoverable. Impairment losses are recognized on the income statement. Under IFRS, an impairment loss exists when the carrying value of an asset exceeds the recoverable amount. The recoverable amount is the greater of its fair value less any selling costs and its value in use. The value in use is the present value of its future cash flow. Under U.S.GAAP, an asset is tested for impairment only when events and circumstance indicate the firm may not be able to recover the carrying value through future use. Recoverability test. An asset is considered impaired if the carrying value (original cost less accumulated depreciation) is greater than the asset’s future undiscounted cash flow stream. Loss measurement. If impaired, the asset’s value is written down to fair value on the balance sheet and a loss, equal to the excess of carrying value over the fair value of the asset (or the discounted value of its future cash flows if the fair value is not known), is recognized in the income statement.

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18. 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.

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.

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19. A company prepares its financial statements in accordance with U.S. GAAP (generally accepted accounting principles). It expected to be the sole supplier for a state-wide school milk program and had production facilities valued at $28.4 million. Recently several other companies were also granted milk-supply contracts throughout the state and the company now estimates that it will only be able to generate cash flows of $3 million per year for the next 7 years with its facilities. The firm has a cost of capital of 10%. The impairment loss (in $-millions) on the production facilities will most likely be reported in the company’s financial statements as a: A. 13.8 reduction in operating cash flows. . B. 13.8 impairment loss in the income statement C. 7.4 reduction in the balance sheet carrying amount.

Ans: B. The company will report an impairment loss in the income statement: The facilities fail the recoverability test, the net book value cannot be recovered from undiscounted cash flows: 7 yrs x $3 = $21 < $28.4. Therefore, the asset is impaired. The asset should be written down to its fair value. Fair Value: PV of future benefits: (N=7; i=10; PMT=3): PV = 14.6 Impairment Loss: Carrying Value – Fair Value: 28.4 - 14.6 = 13.8 to be reported on the income statement

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20. An analyst gathers the following information ($ millions) about three companies operating in the same industry: Company Annual Depreciation Expense Accumulated Depreciation 1 10.8 58.9 2 27.8 80.3 3 33.6 128.8 Although the companies have different levels of sales and assets, they are all experiencing sales growth at about the same rate and use the same type of equipment in the manufacturing process. All three companies also use the same depreciation method. Which company is least likely to require major capital expenditures in the near future? Company: A. 1. B. 2. C. 3.

Ans: B. Average age of assets = accumulated depreciation/annual depreciation expense Company 1: 58.9/10.8 = 5.5 years Company 2: 80.3/27.8 = 2.9 years Company 3: 128.8/33.6 = 3.8years Because Company 2 has the lowest average age of assets, it is least likely to need major capital expenditures.