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Financial Reporting and Analysis 【Reading 30】Sample

When comparing capitalizing versus expensing costs which of the following statements is most accurate?
A)
Expensing costs creates lower cash flows from operations and lower cash flows from investing.
B)
Capitalizing costs creates higher 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.



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.

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.



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.

TOP

Which of the following statements regarding the capitalization of an expense is least accurate?
A)
Capitalizing an expense creates an asset.
B)
Capitalizing an expense lowers current period net income.
C)
Capitalized expenses increases equity.



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.

TOP

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.



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.

TOP

Capitalized interest costs are typically reported in the cash flow statement as an outflow from:
A)
investing.
B)
operating.
C)
financing.



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.

TOP

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 lower equity levels.
B)
lower asset levels and higher equity levels.
C)
lower asset levels and lower liability levels.



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.

TOP

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.



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.

TOP

Which of the following items is least likely an example of an intangible asset with an indefinite life?
A)
Goodwill.
B)
Acquired patents.
C)
Trademarks that can be renewed at minimal cost.



Acquired patents are most likely purchased with the intent to use over a specific period of time and therefore would be an example of an intangible asset with a finite life. Goodwill, by definition, is an intangible asset with an indefinite life. Trademarks that can be renewed at minimal cost are also considered to be intangible assets with infinite lives.

TOP

During 2007, Big 4 Company’s warehouse was totally destroyed by a tornado. Tornados are very rare in the region where Big 4 is located. The book value of the warehouse at the time of the tornado was €10 million and Big 4 is self-insured. In addition, on June 30, 2007, Big 4 acquired one of its major suppliers. The fair value of the net assets acquired by Big 4 was greater than the purchase price. According to International Financial Reporting Standards, should Big 4 recognize an extraordinary item for tornado damage and should Big 4 recognize negative goodwill on its balance sheet due to the acquisition?
Extraordinary loss Negative goodwill
A)
No No
B)
Yes No
C)
No Yes



IFRS does not permit income statement items to be recognized as “extraordinary” in the income statement. Negative goodwill is not reported on the balance sheet; rather, the excess of fair value over the price paid in an acquisition is recognized as a gain in the income statement.

TOP

Which of the following statements comparing straight-line depreciation methods to alternative depreciation methods is least accurate? Companies that use:
A)
accelerated depreciation methods will decrease the amount of taxes in early years.
B)
the units-of-production method to depreciate assets will overstate income during periods of low production.
C)
accelerated depreciation methods will increase the total amount of depreciation expense over the life of an asset.



Accelerated depreciation methods will not change the total amount of depreciation expense over the life of an asset. Accelerated depreciation methods will increase the amount of depreciation expense in the early years of the asset’s life, but the depreciation expense will be less in the latter years of the asset’s life.

TOP

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