土豆妮

Train, Inc.’s cash flow from operations (CFO) in 2004 was $14 million. Train paid $8 million cash to acquire a franchise at the beginning of 2004 that was expensed in 2004. If Train had elected to amortize the cost of the franchise over eight years, 2004 cash flow from operations (CFO) would have been:

A) $22 million.

B) unchanged.

C) $21 million.

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If Train decided to amortize the franchise cost, it would be capitalized and $1 million each year would be treated as a reduction in cash flow from investing (CFI). None of the cash expended would flow though CFO, and all of the $8 million would be added back to CFO.

土豆妮

 

Selected information from Willingham Corp.’s financial statements for the year ended December 31 included the following (in $ millions):

Accounts Payable	12
Long-term Debt	32
Common Stock	10
Retained Earnings	16
Total Liabilities and Equity	70

During the year, Willingham paid $14 million cash to purchase a franchise and fully expensed the franchise cost.  If the company had elected to amortize the franchise cost over 7 years instead of expensing it, Willingham’s total asset-to-equity ratio would be closest to:

A) 3.15.

B) 1.84.

C) 2.16.

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Given that total assets must equal total liabilities and equity, Willingham’s total asset-to-equity ratio was 70 / (10 + 16) = 2.69. If the franchise cost were amortized, retained earnings would be $12 million higher ($14 million cost less 14 / 7 = $2 million of amortization). The total asset-to-equity ratio would decrease to (70 + 12) / (10 + 16 + 12) = 2.16.

土豆妮

Capitalized interest costs are typically reported in the cash flow statement as an outflow from:

A) operating.

B) investing.

C) financing.

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Capitalized interest costs are reported as CFI on the statement of cash flows, as they are treated as part of the cost of the constructed capital asset.

土豆妮

The management of Berger Investments has changed their policy and will capitalize some costs instead of expensing them. Due to the new policy, Berger will:

A) report a smooth income pattern initially, but income variability will increase over time.

B) have lower income variability as it grows, but the variability will increase as the firm matures.

C) have smoother reported income over time.

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If management decides to capitalize costs instead of expensing them, it will report smoother reported income over time. If the firm decided to expense costs as incurred, it will have greater variability in reported income. This variability declines as the firm matures and is lower for larger firms.

土豆妮

Under U.S. generally accepted accounting principles (GAAP), which of the following costs associated with intangible assets is most likely to be capitalized?

A) Research and development costs associated with software development.

B) The cost of an acquisition of a patent from an outside entity.

C) The costs associated with an internally created trademark.

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The cost of an acquisition of a patent from an outside entity is correct because this cost may be capitalized.

土豆妮

Capitalizing interest costs related to a company’s construction of assets for its own use is required by:

A) IFRS only.

B) both IFRS and U.S. GAAP.

C) U.S. GAAP only.

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Both U.S. GAAP and IFRS require companies to capitalize the interest that accrues during a the construction of capital assets for their own use.

土豆妮

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 (ignore taxes):

A) increase from 0.474 to 0.551.

B) decrease from 0.298 to 0.262.

C) decrease from 0.474 to 0.403.

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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.

土豆妮

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%.

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% to:

A) 35.6%.

B) 31.1%.

C) 38.9%.

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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%.

土豆妮

Compared with firms that expense costs, firms that capitalize costs can be expected to report:

A) higher asset levels and higher equity levels in the early years of the asset's life.

B) higher asset levels and lower equity levels in the early years of the asset's life.

C) lower asset levels and higher equity levels in the early years of the asset's life.

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The capitalized cost is recorded as an asset, which is then expensed in the form of depreciation over future years. Spreading the depreciation out over future years causes net income to increase along with retained earnings and equity in the early years of the asset’s life.

土豆妮

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

A) Capitalizing an expense creates an asset.

B) Capitalized expenses increases equity.

C) Capitalizing an expense lowers current period net income.

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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.