Reading 37: Long-Lived Assets LOShB习题精选 statements, face, 2010, including, following

honeycfa

LOS b: Compute and describe the effects of capitalizing versus expensing on net income, shareholders' equity, cash flow from operations, and financial ratios, including the effect on the interest coverage ratio of capitalizing interest costs.

For firms that expense rather than capitalize costs, which of the following statements is least accurate?

A) Lower ROA and ROE will occur because of higher asset and equity levels in the early years.

B) Net cash flows are the same regardless of which method is used.

C) Higher debt/equity and debt/assets will occur because of lower asset and equity levels.

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Firms that expense costs versus capitalize costs, they will have a lower ROE and ROA in early years because of lower profits and not due to higher assets and equity levels (actually the assets and equity are lower due to expensing the costs).

shxjm

thanks

honeycfa

Income statement information for Quick Corp. for the years ended December 31, 20X0 and 20X1 was as follows (in $ millions):

	20X0	20X1
Sales	30,000,000	32,000,000
Cost of Goods Sold	(16,000,000)	(17,000,000)
Gross Profit	14,000,000	15,000,000
Amortization of Franchise	(1,500,000)	(1,500,000)
Other Expenses	(7,000,000)	(7,000,000)
Net Income	5,500,000	6,500,000

Quick acquired a franchise in 20X0 for $15,000,000 and elected to amortize the cost over 10 years. Ignoring taxes, if Quick had expensed the franchise cost in 20X0 instead of amortizing it, net income for 20X0 and 20X1 would be:

20X0

20X1

A) -$9,500,000   $8,000,000

B) -$8,000,000   $8,000,000

C) -$8,000,000   $6,500,000

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If the franchise cost were expensed, amortization would be eliminated and franchise expense would be fully taken in 20X0. 20X0 net income would be $5,500,000 + 1,500,000 - $15,000,000= -$8,000,000, and 20X1 net income would be $6,500,000 + $1,500,000= $8,000,000.

honeycfa

Which of the following statements regarding capitalizing versus expensing costs is least accurate?

A) Capitalization results in higher profitability initially.

B) Total cash flow is higher with capitalization than expensing.

C) Cash flow from investing is higher with expensing than with capitalization.

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Total cash flow is higher with capitalization than expensing is least accurate because total cash flow would be the same under both methods, not considering tax implications.

honeycfa

 

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) 2.16.

C) 1.84.

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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.

honeycfa

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.

honeycfa

A firm that capitalizes rather than expensing costs will have:

A) lower cash flows from investing.

B) lower cash flows from operations.

C) lower profitability in the earlier years.

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A firm that capitalizes costs classifies them as an investing cash flow rather than an operating cash flow. Investing cash flows will be lower and cash flow from operations will be higher when costs are capitalized.

honeycfa

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 debt to equity ratio.

B) higher net cash flows.

C) greater initial return on assets.

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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.)

honeycfa

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

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

B) higher asset levels and higher 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.

honeycfa

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 0.298 to 0.262.

B) increase from 0.474 to 0.551.

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.