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50. Two growing firms are identical except that A Company capitalizes costs for some long-lived assets that C Company expenses. For these two firms, which of the following financial statements effects is most likely? A Company will show higher: A. net income than C Company. B. working capital than C Company. C. investing cash flow than C Company.

Ans: A. For growing firms, capitalizing results in higher net income compared to expensing. A capitalizing company classifies the costs of the capitalized assets as CFI outflows, while a company that expenses these costs classifies them as CFO outflows. Thus, A Company’s CFO will be higher and CFI than C Company’s working capital is unaffected by the decision to capitalize or expense because the decision does not affect current assets or current liabilities.

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51. A company takes a $10 million impairment charge on a depreciable asset in 2011. The most likely effect will be to: A. increase reported net income in 2012. B. decrease net income and taxes payable in 2011. C. increase return on equity and operating cash flow in 2012.

Ans: A. The impairment write-down in 2011 will reduce depreciation expense in 2012, which will increase 2012 EBIT and net income. Operating cash flow and taxes payable are not affected because an impairment cannot be deducted from income for tax reporting purposes until the asset is sold or otherwise disposed of.

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52. East Company incurs $110,000 of costs to establish technological feasibility of a new software application it hopes to sell and $90,000 of costs to develop the application. West Company incurs $110,000 of research costs related to a new product and $90,000 of development costs for the product. If East reports under U.S.GAAP and West reports under IFRS, these projects will: A. increase East’s total assets more the West’s total assets. B. increase West’s total assets more the West’s total assets. C. have the same effects on East’s and West’s total assets.

Ans: C. Under U.S.GAAP, costs incurred to establish technological feasibility has been established must be capitalized. Under IFRS, research costs are expensed as incurred and development costs are capitalized. Thus, both East and West will capitalize $90,000 of development costs.

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53. A company that capitalizes costs instead of expensing them will have: A. higher income variability and higher cash flows from operations. B. lower cash flows from investing and lower income variability. C. lower cash flows from operations and higher profitability in early years.

Ans: B. Capitalizing costs tends to smooth earnings and reduces investment cash flows. It will also increase cash flows from operating and increase profitability in the early years.

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54. Harding Corp. has a permanently impaired asset. The difference between its carrying value and the present value of its expected cash flow should be written down immediately and: A. reported as an operating loss. B. charged directly against retained earnings. C. reported as non-operating loss in other comprehensive income.

Ans: A. Impairment writedowns are reported losses “above the line” and are included in income from continuing operations.