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45. Bao Company has revalued an intangible asset with an indefinite life upward by €25 million. In its financial statements, Bao will most likely: A. disclose how it determined the fair value of the intangible asset. B. report lower net income in subsequent periods because of increased amortization expense on the asset. C. report higher assets, net income, and shareholders’ equity in the most recent period than it would have reported under the cost model.

Ans: A. For firms that revalue assets upward, IFRS requires disclosure of the date the asset was revalued, how management determined its fair value, the asset’s carrying value using the historical cast model, and (for intangible assets) whether the asset’s useful life is finite or indefinite. Although assets and shareholders’ equity will increase as a result of the revaluation, net income will not increase. The increase in the value of the asset is reported as a revaluation surplus in shareholders’ equity. Amortization expense will not increase because indefinite-lived intangible assets are not amortized.

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44. Bao Inc. owns a machine with a carrying value of $3.0 million and a salvage value of $2.0 million. The present value of the machine’s future cash flows is $1.7 million. The asset is permanently impaired. Bao should (under IFRS): A. immediately write down the machine to its salvage value. B. immediately write down the machine to its recoverable amount. C. write down the machine to its recoverable amount as soon as it is depreciated down to salvage value.

Ans: B. Under IFRS, when an asset is permanently impaired, it must be written down to its recoverable amount (greater of value in use or fair value less selling costs) in the period in which the impairment is recognized.

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43. Under U.S.GAAP, an asset is considered impaired if its book value is: A. less than its market value. B. greater than the present value of its expected future cash flows. C. greater than the sum of its undiscounted expected cash flows.

Ans: C. Under U.S.GAAP, an asset is considered impaired when its book values is greater than the sum of the estimated undiscounted future cash flows from its use and disposal.

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42. A manufacturing firm shuts down production at one of its plants and offers the facility for rent. Based on the market for similar properties, the firm determines that the fair value of the plant is €500,000 more than its original cost. If this firm uses the cost model for plant and equipment and the fair value model for investment property, should it recognize a gain on its income statement under IFRS? A. Yes, because the plant will be reclassified as investment property. B. No, because the increase in value does not reverse a previously recognized loss. C. No, because the firm must continue to use the cost model for valuation of this asset.

Ans: B. According to IFRS, property held for the purpose of earning rental income is classified as investment property. However, when a property is transferred from owner-occupied to investment property, a firm using the fair value model must treat any increase in the property’s value as a revaluation. That is, the firm may only recognize a gain on the income statement to the extent that it reverses a previously recognized loss.

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42. In the early years of an asset’s life, a firm that chooses an accelerated depreciation method instead of using straight-line depreciation will tend to have: A. lower net income and lower equity. B. higher return on equity and higher return on assets. C. lower depreciation expense and lower turnover ratios.

Ans: A. These relationships are reversed in the later years of the asset’s life if the firm’s capital expenditures decline.

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41. Which of the following statement about expenses and intangible assets is least accurate? A. advertising fees are generally expensed as incurred. B. In most countries, research and development costs are capitalized. C. Intangible assets are initially entered on the balance sheet at their purchase prices when they are acquired from an outside entity.

Ans: B. U.S.GAAP requires R&D costs to be expensed. IFRS requires research costs to be expensed, but development costs are capitalized.

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40. In the period when a firm makes an expenditure, capitalizing the expenditure instead of recognizing it as an expense will result in higher: A. debt-to-equity and debt-to-assets ratios. B. net income and have no effect on total cash flows. C. cash flow from investing and lower cash flow from operations.

Ans: B. Net income is higher with capitalization because it does not decrease by the full amount spent, as it would with expensing. Capitalizing expenditure changes its cash flow classification from an operating cash outflow to an investing cash outflow. As a result, CFO is higher and CFI is lower than they would be if the expenditure had been immediately expensed. Total cash flow, however, is unaffected (assuming the tax treatment of the expenditure is independent of the financial reporting treatment). Equity is higher in the period of the expenditure with capital capitalization. Assets are higher because they include the capitalized asset. Debt is unaffected by the decision to capitalize or expense. Thus, the debt-to-equity and debt-to-assets ratios are lower with capitalization. References: question 3.

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39. A firm that rents DVDs to customers capitalizes the cost of newly released DVDs that it purchases and depreciates them over years to a value of zero. Based on the underlying economics of the DVD rental business, the most appropriate method of depreciation for the firm to use on its financial statements is: A. straight-line. B. declining balance. C. units-of-production.

Ans: B. Since the value of newly released DVDs will typically fall most rapidly in the first year after their release, some form of accelerated depreciation is appropriate. The declining balance method is the only accelerate depreciation method among the answer choices. A is incorrect. Straight-line depreciation is appropriate when the decrease in value is uniform over an asset’s life. C is incorrect. Units-of-production depreciation assumes that there is a given amount of service that an asset will provide.

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38. Two companies are identical except for their accounting treatment of research and development costs. On e company expenses all such costs immediately, while the other company capitalizes a portion of the costs. Compared to the company that capitalizes costs, the company that expenses immediately will most likely: A. earn a lower ROA. B. have a lower financial leverage. C. report lower cash flow from operations in the statement of cash flows.

Ans: C. Companies that capitalize research and development costs report those expenditures in the investing activities section of the statement of cash flows; companies that expense research and development costs report those expenditures in cash flow from operations. A is incorrect. ROA=. The company expensing all research and development costs has both lower NI and lower total assets, while the company capitalizing all the research and development costs has both higher NI and higher total assets. So whose ROE is lower cannot be determined. B is incorrect. Financial leverage = The company expensing all research and development costs has both lower total assets and lower total equity, while the company capitalizing all the research and development costs has both higher total assets and higher total equity. So whose ROE is lower cannot be determined.

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37. Bao Incorporated recently paid more than the net book value to acquire Cleanway Corporation. Cleanway operates an active research and development program into environmentally friendly cleaning products. Bao is very interested in this research program as well as the good management team in place at Cleanway. The excess price paid over the net book value of the assets should be accounted for on Bao’s financial statements as: A. goodwill. B. a trademark. D. an intangible asset, research and development.

Ans: A. The excess price paid over the net book value during an acquisition that cannot be assigned to other identifiable assets is assumed to be for goodwill. Goodwill is said to be an unidentifiable asset that cannot be separated from the business itself.