On January 1, Year 1, a firm purchases a
machine for $68,000 that has an estimated
useful life of five years, at which time it will
have a salvage value of $10,000. Using the
double-declining balance method, Year 3
depreciation expense is closest to:
A. $27,200
B.$16,320
C. $9,792
Ans: C
Double-declining balance method does not
consider salvage value when calculating
depreciation. So depreciation expense on:
Year 1= 2/5($68,000-0)= $27,200
Year 2= 2/5($68,000-27,200)=$16,320
Year 3= 2/5 ($68,000-27,200-16,320)=$9,792
The effects on a firm’s financial statement
in the initial year when cost of an asset is
expensed rather than capitalized are:
A. Pre-tax cash flow is lower and the debt-to-
equity ratio is higher.
B. Pre-tax cash flow remains the same and
the debt-to-equity ratio is lower.
C. Pre-tax cash flow remains the same and
the debt-to-equity ratio is higher.
Ans: C
Pre-tax cash flow stays the same because
depreciation (or amortization) is a non-cash
expense.
However, when the cost is expensed rather then
capitalized, net income and retained earnings are
lower, resulting in a lower equity. So the debt-to-
equity ratio will be higher.
A company records an asset retirement
obligation (ARO) because of environmental
damage. Which of the following will most
likely result from the recording an ARO in any
given year?
A. An increase in return on equity and an
increase in depreciation expense
B. An decrease in return on equity and an
increase in depreciation expense
C. An decrease in return on equity and an
decrease in depreciation expense
Ans: B
Obligation associated with the retirement of
tangible fixed assets are referred to as asset
retirement obligations (AROs) and include costs for
cleaning up the operating site and restoring it to
pre-existing conditions, including rectifying any
environmental damages.
ARO accounting requires companies to record an
asset and a related liability for costs incurred to
remedy environmental damage. The asset increase
will result in an increase in depreciation expense
that will reduce net income. Lower net income will
reduce the company’s return on equity
Impact of depreciation method on Financial statement
SL method
Dep. expense
Net income
assets
equity
ROA
ROE
Asset turnover
operating profit margin
current ratio
Debt/equity
Impact of depreciation method on Financial statement
DDB method
Dep. expense
Net income
assets
equity
ROA
ROE
Asset turnover
operating profit margin
current ratio
Debt/equity
Impact on Financial statement
Expensing
Equity
Earnings
Pre-tax cash generated
CFI
pre-tax cash flow
profit margin
asset turnover
current ratio
debt to equity
Roa
Roe
Impact on Financial statement
Capitalizing
Equity
Earnings
Pre-tax cash generated
CFI
pre-tax cash flow
profit margin
asset turnover
current ratio
debt to equity
Roa
Roe
Which of the following would most likely be
lower in the early years of an asset’s life using
accelerated depreciation methods rather than
straight-line depreciation?
A. Investing cash flow
B. Shareholder’s equity
C. Cash flow from operations
Ans: B
The greater depreciation expense in the early
years of an asset’s life using accelerated
depreciation methods rather than straight-line
depreciation would lead to lower net income and
lower retained earnings in those years. Lower
retained earnings would result in lower
shareholders’ equity.
An analyst is comparing the financial
statements of Company A and Company B.
both companies have incurred expenses of
approximately $250 million in the current year
to expand their production facilities. Company
A is highly leveraged. Company B does not
have any outstanding debt and paid the $250
million from internal cash reserves. The most
likely effect of the difference in the capital
structures of the two companies will be:
A. Company A will report higher asset
balances related to the facilities under
construction.
B. The companies will report the same asset
balances related to the facilities under
construction.
C. Company A’s interest coverage ratio will be
lower than it would have been if the company
had expensed all interest.
Ans. A.
Since Company A is leveraged, it will be required
to capitalize the interest related to the
construction project even if there was no
borrowing specially for the $250 million (an
assumption is made that the money actually came
from some kind of borrowing, even if there is no
specific loan for the amount). Company B on the
other hand, will not have any interest to capitalize.
As a result, Company A’s balance sheet will reflect
an amount in excess of the $250 million for the
facilities under construction, while Company B will
reflect only the $250 million.
guardare domanda 8
During the early years of an asset’s life, a
company using an accelerated depreciation
method, rather than straight-line, could
expect a lower value for:
A. Asset turnover.
B. Shareholders’ equity.
C. Asset turnover and shareholders’ equity.
Ans: B.
Shareholders’ equity would be less during the
early years of the asset’s expected life because
depreciation expense is higher, net income is
lower, and retained earnings is lower. Asset
turnover (sales/assets) is greater during the early
years because accelerated depreciation increase
accumulated depreciation at a faster rate than
doer straight-line, thus reducing assets and
increasing asset turnover.
A company has announced that it is going
to distribute a group of long-lived assets to its
owners in a spin-off. The most appropriate
way to account for the assets until the
distribution occurs is to classify them as:
A. held for sale with no depreciation taken.
B. held for use until disposal with no
deprecation taken.
C. held for use until disposal with depreciation
continuing to be taken.
Ans. C.
Long-lived assets that will be disposed of other
than by sale, such as a spin-off, an exchange for
other assets, or abandonment, are classified as
held for use until disposal and continue to be
depreciated until that time.
At the start of the year, a company
acquired new equipment at a cost of €50,000,
estimated to have a 3 year life and a residual
value of €5,000. If the company depreciates
the asset using the double declining balance
method, the depreciation expense that the
company will report for the third year is
closest to:
A. €555.
B. €3,328.
C. €3,705.
Ans: A
Depreciation cannot be 2/3 x 5,555 = 3,705
since that would reduce book value to below
the estimated 5,000
anche nell’units of production tieni conto del residual value
A company, which prepares its financial
statements in accordance with IFRS uses the
revaluation model to value land. At the end of
the current year the land value of the land has
increased and will be adjusted on the balance
sheet. Which of the following statements is
most accurate? In the current period the
revaluation of the land will:
A. increase return on sales.
B. increase return on assets.
C. decrease the debt to equity ratio.
Ans: C.
The increase in the value of the land bypasses the
income statement and goes directly to a
revaluation surplus account in equity. Equity
increases thereby decreasing the debt to equity
ratio.
- Which of the following is the least likely
reason as to why a firm’s management would
increase the value of a capital asset that had
been previously written down?
A. Management wants to increase ROE in
future periods.
B. The company is approaching the leverage
limits of its borrowing agreement.
C. Management is concerned that income for
the current year will fall below levels expected
by analysts.
Ans: A.
The increase in an asset’s value would increase
depreciation expense and therefore decrease ROE
in future periods, not increase it. An asset
revaluation that reverses a previous downward
revaluation is reported in net income in the period
it is revalued. Hence management can use upward
revaluations to increase net income (and hence
meet the analysts’ expectations). This one-time
increase in net income would increase ROE for the
current year only.
Two software companies that report their
financial statements under U.S. GAAP
(generally accepted accounting principles) are
identical except as to how soon they judge a
project to be technologically feasible. One firm
does so very early in the development cycle
while the other usually waits until just before
the project is released to manufacturing.
Compared to the company that judges
technological feasibility early, the one that
waits until closer to manufacturing will most
likely report lower:
A. financial leverage.
B. total asset turnover.
C. cash flow from operations.
Ans: C.
U.S. GAAP requires that a company expense costs
related to software development until product
feasibility is established and capitalize any costs
thereafter. The company that capitalizes these
software development costs reports the
expenditures in the investing activities section of
the statement of cash flows; the company that
expenses software development costs reports the
expenditures in the cash flow from operations.
A company acquires some new
depreciable assets. Which of the following
combinations of estimated salvage value and
useful life will most likely produce the highest
net profit margin?
A. low salvage value estimates and long
average lives.
B. high salvage value estimates and long
average lives.
C. high salvage value estimates and short
average lives.
Ans: B.
A high salvage value estimate reduces the
depreciable base and thus depreciation expense;
long average lives reduce the annual depreciation
expense for any givendepreciable base. The
combination of the two would result in the lowest
depreciation expense which leads to the highest
net income and profit margins.
guardare domanda 25-26
guardare domanda 28
The capitalization of interest (versus
expensing) will have which of the following
effects on a company’s financial ratios?
A. Lower interest coverage ratio.
B. Lower debt-to-equity ratio.
C. Higher asset turnover ratio.
Ans: B.
The capitalization of interest will increase
shareholders’ equity, resulting in a lower debt-to-
equity ratio.
A is incorrect. Since interest expense
(denominator) will be lower when interest is
capitalized, the interest coverage ratio will be
higher, not lower.
C is incorrect. The capitalization of interest will
result in a larger asset base and a lower asset
turnover ratio (sales/ average assets).
Bao Incorporated recently paid more than
the net book value to acquire Cleanway
Corporation. Cleanway operates an active
research and development program into
environmentally friendly cleaning products.
Bao is very interested in this research
program as well as the good management
team in place at Cleanway. The excess price
paid over the net book value of the assets
should be accounted for on Bao’s financial
statements as:
A. goodwill.
B. a trademark.
D. an intangible asset, research and
development.
Ans: A.
The excess price paid over the net book value
during an acquisition that cannot be assigned to
other identifiable assets is assumed to be for
goodwill. Goodwill is said to be an unidentifiable
asset that cannot be separated from the business
itself.
Two companies are identical except for
their accounting treatment of research and
development costs. On e company expenses
all such costs immediately, while the other
company capitalizes a portion of the costs.
Compared to the company that capitalizes
costs, the company that expenses
immediately will most likely:
A. earn a lower ROA.
B. have a lower financial leverage.
C. report lower cash flow from operations in
the statement of cash flows.
Ans: C.
Companies that capitalize research and
development costs report those expenditures in
the investing activities section of the statement of
cash flows; companies that expense research and
development costs report those expenditures in
cash flow from operations.
In the period when a firm makes an
expenditure, capitalizing the expenditure
instead of recognizing it as an expense will
result in higher:
A. debt-to-equity and debt-to-assets ratios.
B. net income and have no effect on total cash
flows.
C. cash flow from investing and lower cash
flow from operations.
Ans: B.
Net income is higher with capitalization because it
does not decrease by the full amount spent, as it
would with expensing. Capitalizing expenditure
changes its cash flow classification from an
operating cash outflow to an investing cash
outflow. As a result, CFO is higher and CFI is lower
than they would be if the expenditure had been
immediately expensed. Total cash flow, however, is
unaffected (assuming the tax treatment of the
expenditure is independent of the financial
reporting treatment). Equity is higher in the period
of the expenditure with capital capitalization.
Assets are higher because they include the
capitalized asset. Debt is unaffected by the
decision to capitalize or expense. Thus, the debt-
to-equity and debt-to-assets ratios are lower with
capitalization.
