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Capitalized interest costs are typically reported in the cash flow statement as an outflow from:

A) operating.

B) investing.

C) financing.

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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.

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Capitalizing interest costs related to a company’s construction of assets for its own use is required by:

A) both IFRS and U.S. GAAP.

B) IFRS only.

C) U.S. GAAP only.

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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.

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Under U.S. generally accepted accounting principles (GAAP), which of the following costs associated with intangible assets is most likely to be capitalized?

A) Research and development costs associated with software development.

B) The costs associated with an internally created trademark.

C) The cost of an acquisition of a patent from an outside entity.

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The cost of an acquisition of a patent from an outside entity is correct because this cost may be capitalized.

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

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

B) higher asset levels and lower 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.

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Selected information from the financial statements of Salvo Company for the years ended December 31, 2003 and 2004 is as follows (in $ millions):

	2003	2004
Sales	$21	$23
Cost of Goods Sold	(8)	(9)
Gross Profit	13	14
Cost of Franchise	(6)	0
Other Expenses	(6)	(6)
Net Income	$1	$8
Cash	$4	$5
Accounts Receivable	6	5
Inventory	9	7
Property, Plant & Equip. (net)	12	15
Total Assets	$31	$32
Accounts Payable	$7	$5
Long-term Debt	10	5
Common Stock	8	8
Retained Earnings	6	14
Total Liabilities and Equity	$31	$32

Salvo’s return on average total equity for 2004 was ($8 / (($8 + $6) + ($8 + $14)) / 2 =) 44.4%.
If Salvo had amortized the cost of the franchise acquired in 2003 over six years instead of expensing it, Salvo’s return on average total equity for 2004 would have decreased from 44.4% to:

A) 35.6%.

B) 38.9%.

C) 31.1%.

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If the franchise cost had been amortized over six years beginning in 2003, net income in 2003 would have been $6 million instead of $1 million due to the cost of franchise expense of $6 million being eliminated and replaced by franchise amortization of $1 million. Net income in 2004 would have been reduced by the franchise amortization to $7 million instead of $8 million. On the equity side, retained earnings at the end of 2003 would have been $11 million ($5 million higher), and total equity for 2003 would have been ($8 + $11 =) $19 million. Retained earnings for 2004 would be the 2003 retained earnings of $11 million increased by 2004 net income of $7 million for a total of $18 million, and total equity for 2004 would be ($8 + $18 =) $26 million. If the franchise cost were amortized, return on total equity for 2004 would be ($7 / ((19 + 26) / 2 =) 31.1%.

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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 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.

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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.