JonnyKay

Which of the following statements about the impact of leases on the financial statements of the lessee is least accurate?

A) Net income is lower in the early years of a finance lease than an operating lease.

B) A finance lease results in higher liabilities compared to an operating lease.

C) Cash flow from investing is higher for a finance lease than an operating lease.

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Cash flow from investing is not affected by a lease being either a finance or an operating lease. Finance leases reduce cash flow from operations by only the portion of the lease payment attributed to interest expense. Cash flow from financing is reduced by the rest of the finance lease payment which is the principal part of the payment.

JonnyKay

Which of the following is least likely one of the criteria under U.S. GAAP for classifying a lease as a finance lease? The:

A) lease contains a bargain purchase option.

B) term of the lease is 75% or more of the estimated economic life of the leased property.

C) lessor retains ownership of the property at the end of the lease term.

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If the lease transfers ownership of the property to the lessee at the end of the lease term, the lessee will classify the lease as a finance lease.

JonnyKay

Compared to a finance lease, an operating lease is most likely to be favored when:

A) management compensation is not based on returns on invested capital.

B) the lessee has bond covenants relating to financial policies.

C) at the end of the lease, the lessee may be better able to sell the asset than the lessor.

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If the lessee has bond covenants (e.g., debt-to-equity ratio) relating to its financial policies that it must follow, it is best to have an operating lease due to the fact that the operating lease will keep the asset off of the balance sheet resulting in less liabilities.

JonnyKay

The lessee has an incentive to classify a lease as an operating lease, rather than as a finance lease, because an operating lease:

A) has no risk involved because the lessor assumes all risk.

B) does not appear on the balance sheet.

C) has payments that are less than a capital lease's payments.

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Having less assets and liabilities on the balance sheet than would exist if the asset were purchased increases profitability ratios (e.g., return on assets) and decreases leverage ratios (e.g., the debt to equity ratio).

JonnyKay

A firm using straight-line depreciation reports the following financial information:

• Gross investment in fixed assets of $89,167,205.
• Accumulated depreciation of $35,341,773.
• Annual depreciation expense of $3,885,398.

The approximate age of the fixed assets is:

A) 2.52 years.

B) 9.10 years.

C) 22.95 years.

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Average age of fixed assets = accumulated depreciation / annual depreciation = $35,341,773 / $3,885,398 = 9.10.

JonnyKay

Ending gross investment/depreciation expense is used to estimate the average:

A) age as a percent of depreciable life.

B) depreciable life.

C) age.

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Average depreciable life is approximated by: ending gross investment / depreciation expense

JonnyKay

In industries where there are rapid changes in technology related to production processes, which of the following characteristics will most likely indicate that a firm has a competitive advantage?

A) Low average age of equipment.

B) Low capital expenditures.

C) High earnings per share.

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Average age of depreciable assets is useful for two reasons:

• To assess how competitive the corporation will be going forward (older assets are less efficient).

• Estimate financing required for major capital expenditures to replace depreciated assets.

While low capital expenditures may result in higher earnings in the short run, in the long run, the company may find itself at a comparative disadvantage if technological changes are rapidly increasing. EPS is not comparable between companies.

JonnyKay

An analyst will most likely use the average age of depreciable assets to estimate the company’s:

A) cash flows.

B) earnings potential.

C) near-term financing requirements.

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Average age of depreciable assets is useful for two reasons:

• To assess how competitive the corporation will be going forward (older assets are less efficient).
• To estimate financing required for major capital expenditures in the near-term to replace depreciated assets.

JonnyKay

A manufacturing firm reports the following in its financial statements:

• Gross plant and equipment: $2,700,000.

• Depreciation expense: $235,000.

• Accumulated depreciation: $1,850,000.

The average useful life of plant and equipment is:

A) 19.36 years.

B) 11.49 years.

C) 7.87 years.

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The average useful life = gross investment / depreciation expense
11.49 = $2,700,000 / $235,000

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The average age of plant and equipment is:

A) 1.33 years.

B) 11.49 years.

C) 7.87 years.

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The average age = accumulated depreciation / depreciation expense
7.87 = $1,850,000 / $235,000

JonnyKay

The following information has been gathered regarding a firm that uses straight line depreciation.

• Gross plant and equipment $1,250,000
• Depreciation expense $235,000
• Accumulated depreciation $725,000

The average depreciable life of plant and equipment is:

A) 3.09 years.

B) 8.40 years.

C) 5.32 years.

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The average depreciable life = Gross PPE / Depreciation expense
5.32 = $1,250,000 / $235,000

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Average remaining useful life of the plant and equipment is:

A) 2.23 years.

B) 3.09 years.

C) 5.32 years.

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Remaining useful life = (gross investment – accumulated depreciation) / depreciation expense
2.23 = ($1,250,000 – $725,000) / $235,000

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The average age of plant and equipment is:

A) 3.09 years.

B) 1.40 years.

C) 5.32 years.

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The average age = accumulated depreciation / depreciation expense
3.09 = $725,000 / $235,000