11.Ironman Nutrition has traditionally followed a conservative policy of expensing most costs. However, the new CFO is an advocate of capitalization. During a meeting with company executives he explains that compared to expensing, capitalization is least likely to result in:

A)   lower income variability.

B)   higher net cash flows.

C)   lower debt to equity ratio.

D)   greater initial return on assets.

12.With the increasing scrutiny by the SEC and the financial markets, Dobkin Company decided to expense costs that it would have otherwise capitalized. This will result in:

A)   lower quality earnings; lower assets levels; higher equity levels.

B)   higher quality of earnings; lower asset levels; and lower equity levels.

C)   higher quality of earnings; lower asset levels; and lower liability levels.

D)   lower quality of earnings; higher asset levels; and higher liability levels.

13.Which of the following statements regarding the capitalization of an expense is least accurate?

A)   Capitalizing an expense creates an asset.

B)   Capitalizing an expense lowers current period net income.

C)   Capitalized expenses are amortized in the future.

D)   Capitalized expenses increases equity.

14.Selected information from the financial statements of Salvo Company for the years ended December 31, 2003 and 2004 is as follows (in $ millions):

Salvo’s return on average total equity for 2004 was ($8 / (($8 + $6) + ($8 + $14)) / 2 =) 44.4 percent.

If Salvo had amortized the cost of the franchise acquired in 2003 over six years instead of expensing it, Salvo’s return on average total equity for 2004 would have decreased from 44.4 percent to:

A)   38.9 percent.

B)   35.6 percent.

C)   31.1 percent.

D)   25.6 percent.

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

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)   decrease from 0.474 to 0.403.

B)   increase from 0.474 to 0.551.

C)   remain unchanged.

D)   decrease from 0.298 to 0.262.

答案和详解如下：

11.Ironman Nutrition has traditionally followed a conservative policy of expensing most costs. However, the new CFO is an advocate of capitalization. During a meeting with company executives he explains that compared to expensing, capitalization is least likely to result in:

A)   lower income variability.

B)   higher net cash flows.

C)   lower debt to equity ratio.

D)   greater initial return on assets.

The correct answer was B)

There is no difference in net cash flow. However, a firm that capitalizes classifies the expenditure as investing (not operations) cash flow from operations will be higher and cash flow from investing will be lower.

The other statements are correct. Capitalizing firms have higher asset and equity levels (due to the booking of the asset and the higher net income.)

12.With the increasing scrutiny by the SEC and the financial markets, Dobkin Company decided to expense costs that it would have otherwise capitalized. This will result in:

A)   lower quality earnings; lower assets levels; higher equity levels.

B)   higher quality of earnings; lower asset levels; and lower equity levels.

C)   higher quality of earnings; lower asset levels; and lower liability levels.

D)   lower quality of earnings; higher asset levels; and higher liability levels.

The correct answer was B)

Capitalizing expenditures increases assets. Then, since only a portion of the expenditure is amortized, net income is increased compared to if it had been expensed all in one period. Also, any action management takes to speed up recognition of expenses and to avoid overstating net income is seen as conservation and is said to improve the quality of reported earnings.

13.Which of the following statements regarding the capitalization of an expense is least accurate?

A)   Capitalizing an expense creates an asset.

B)   Capitalizing an expense lowers current period net income.

C)   Capitalized expenses are amortized in the future.

D)   Capitalized expenses increases equity.

The correct answer was B)

Capitalizing expenses reduces current period expenses by the amount capitalized. The amount capitalized is added to assets which increases equity by increasing net income and retained earnings in the current period. The asset created by capitalizing expenses will be amortized (reduced) over a period of years.

14.Selected information from the financial statements of Salvo Company for the years ended December 31, 2003 and 2004 is as follows (in $ millions):

	2003	2004
Sales	$21	$23
Cost of Goods Sold	(8)	(9)
Gross Profit	13	14
Cost of Franchise	(6)	0
Other Expenses	(6)	(6)
Net Income	$1	$8
Cash	$4	$5
Accounts Receivable	6	5
Inventory	9	7
Property, Plant & Equip. (net)	12	15
Total Assets	$31	$32
Accounts Payable	$7	$5
Long-term Debt	10	5
Common Stock	8	8
Retained Earnings	6	14
Total Liabilities and Equity	$31	$32

Salvo’s return on average total equity for 2004 was ($8 / (($8 + $6) + ($8 + $14)) / 2 =) 44.4 percent.

If Salvo had amortized the cost of the franchise acquired in 2003 over six years instead of expensing it, Salvo’s return on average total equity for 2004 would have decreased from 44.4 percent to:

A)   38.9 percent.

B)   35.6 percent.

C)   31.1 percent.

D)   25.6 percent.

The correct answer was C)    

If the franchise cost had been amortized over six years beginning in 2003, net income in 2003 would have been $6 million instead of $1 million due to the cost of franchise expense of $6 million being eliminated and replaced by franchise amortization of $1 million. Net income in 2004 would have been reduced by the franchise amortization to $7 million instead of $8 million. On the equity side, retained earnings at the end of 2003 would have been $11 million ($5 million higher), and total equity for 2003 would have been ($8 +$11 =) $19 million. Retained earnings for 2004 would be the 2003 retained earnings of $11 million increased by 2004 net income of $7 million for a total of $18 million, and total equity for 2004 would be ($8 + $18 =) $26 million. If the franchise cost were amortized, return on total equity for 2004 would be ($7 / ((19 + 26) / 2 =) 31.1 percent.

15.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)   decrease from 0.474 to 0.403.

B)   increase from 0.474 to 0.551.

C)   remain unchanged.

D)   decrease from 0.298 to 0.262.

The correct answer was D)

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.