Reading 22: Long-lived Assets: Implications for Financial Sta 2011, statements, period, class, center

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Session 5: Financial Reporting and Analysis: Inventories and Long-lived Assets
Reading 22: Long-lived Assets: Implications for Financial Statements and Ratios

LOS a: Discuss the implications for financial statements and ratios of capitalising versus expensing costs in the period in which they are incurred.

 

 

When comparing capitalizing versus expensing costs which of the following statements is most accurate?

A) Capitalizing costs creates higher cash flows from operations and lower cash flows from investing.

B) Expensing costs creates lower cash flows from operations and lower cash flows from investing.

C) Capitalizing costs creates lower cash flows from operations and higher cash flows from investing.

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Although net cash flows are not affected by the choice of capitalization or expensing, the components of cash flow are affected. Because, a firm that capitalizes classifies the expenditure as investing (not operations), cash flow from operations will be higher for firms that capitalize and investing cash flows will be lower than that of an expensing firm.

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Which of the following is least likely to be a problem with accounting for internally generated intangible assets?

A) Determining the economic life.

B) The potential benefits are spread over a long time period.

C) Costs of developing these assets may not be easily separable.

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The problems with accounting for internally generated intangible assets are: determination of economic life and separation of the cost for development.

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

A) Capitalization results in higher profitability initially.

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

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

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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.

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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) -$8,000,000  $8,000,000

B) -$9,500,000   $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.

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Under U.S. Generally Accepted Accounting Principles (GAAP), development cost of patents and copyrights can be capitalized:

A) when purchased or developed internally but excluding registration costs.

B) when developed internally.

C) when purchased from other entities.

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When patents and copyrights are internally developed, only the legal fees incurred for registration can be capitalized. However, if the patents and copyrights are purchased from other entities, full acquisition cost can be capitalized.

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Under U.S. GAAP, which statement is CORRECT?

A) Goodwill cannot be recognized and capitalized in a purchase transaction.

B) Research and development costs are not expensed.

C) Purchased patent and copyright costs are not expensed.

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Purchased patent and copyright costs are not expensed is correct because these costs are capitalized.

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Statement of Financial Accounting Standard (SFAS) 86 requires that costs incurred to establish the feasibility of computer software must be:

A) capitalized only after the software is completely developed.

B) expensed once the economic feasibility is established.

C) viewed like Research & Development (R&D) costs and expensed as incurred.

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SFAS 86 requires that all the costs incurred in establishing software feasibility be viewed as R&D costs and expensed as incurred. Once technological feasibility has been established, subsequent costs (for software to be sold or leased to others) can be capitalized as part of product inventory.

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Compared to firms that expense costs, firms that capitalize expenses will have:

A) higher leverage ratios.

B) lower cash flow from operations.

C) lower income variablity.

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Firms that capitalize expenses have less variability of net income because the capitalized expense becomes an asset that is depreciated over years instead of all at once which happens when costs are expensed. Capitalizing expenses will result in higher cash flows from operations because capitalizing an expense becomes an investing cash flow instead of an operating cash flow which occurs when expenditures are expensed. Firms that capitalize expenses have lower leverage ratios because assets and equity are increased so any leverage ratio that have assets and equity in the denominator will decrease.

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Dobkin Company decides to expense costs that it would have otherwise capitalized. Compared to capitalizing, expensing these costs will result in:

A) lower asset levels and higher equity levels.

B) lower asset levels and lower equity levels.

C) lower asset levels and lower liability levels.

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Expensing instead of capitalizing results in lower assets. Since the entire expense is recognized in the current period (whereas only a portion of the expenditure is amortized when capitalizing), net income (and therefore equity, via retained earnings) is lower with expensing than with capitalizing. Liabilities are unaffected.

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A firm that capitalizes rather than expensing costs will have:

A) lower cash flows from operations.

B) lower cash flows from investing.

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.