Exam III: Chapters 9, 10, 13

13. Under US GAAP, a lessor's reported revenues at lease inception will be highest if the lease is classified as: A. a sales-type lease. B. an operating lease. C. a direct financing lease.

A. A sales-type lease treats the lease as a sale of the asset, and the revenue is recorded at the time of the sales equal to the present value of future lease payments. Under a direct financing lease, only interest income is reported as earned. Under an operating lease, revenue fro the rent is reported when collected.

23 - 28 SEE BOOK: 26. Based on Exhibits A and B, the best estimate of the average remaining useful life of the company's plant and equipment at the end of 2009 is: A. 20.75 years. B. 24.25 years. C. 30.00 years.

A. The estimated average remaining life is 20.75 years. Estimate of remaining useful life = Net plant and equipment / Annual depreciation expense Net plant and equipment = Gross P&E - Accumulated dep =6000 - 1850 = 4150 Estimated of remaining useful life = Net P&E / Depr exp =4150 / 200 = 20.75

9. Which of the following amortization methods is most likely to evenly distribute the cost of an intangible asset over its useful life? A. Straight-line method B. Units-of-production method C. Double-declining balance method

A. The straight-line method is the method that evenly distributes the cost of an asset over its useful life because amortization is the same amount every year.

2. In early 2009 Sanborn Company must pay the tax authority € 37,000 on the income it earned in 2008. This amount was recorded on the company's 31 December 2008 financial statements as: A. taxes payable. B. income tax expense. C. a deferred tax liability.

A. The taxes a company must pay in the immediate future are taxes payable.

29 through 35 SEE BOOK: 32. Jordan's response about the impact of the different depreciation methods on net profit margin is most likely incorrect with respect to: A. accelerated depreciation. B. straight-line depreciation. C. units-of-production depreciation.

A. Accelerated depreciation will result in an imporving, not declingin, net profit margin over time. because the amount of depreciation expense declines each year. Under straight-line depreciation, the amount of the depreciation expense will remain the same each year. Under the units-of-production method, the amount of depreciation expense reported each year varies with the number of units produced.

14. An analyst is studying the impairment of the manufacturing equipment of WLP Corp., a U.K.-based corporation that follows IFRS. He gathers the following information about the equipment: Fair value - £ 16,800,000 Costs to sell - £ 800,000 Value in use - £ 14,500,000 Net carrying amount - £ 19,100,000 The amount of the impairment loss on WLP Corp.' s income statement related to its manufacturing equipment is closest to: A. £ 2,300,000. B. £ 3,100,000. C. £ 4,600,000.

B. The impairment loss equals £3,100,000. impairment = max(recoverable amount; value in use) - net carrying amount = max(16,800,000 - 800,000; 14,500,000) - 19,100,000 = - 3,100,000

12 - 14 SEE BOOK: 12. In 2007, the company's US GAAP income statement recorded a provision for income taxes closest to: A. $ 30,632. B. $ 54,144. C. $ 58,772.

B. The income tax provision in 2007 was $54,144, consisting of $58,772 in current income taxes, of which $4,628 were deferred.

11. Which of the following is most likely a lessee's disclosure about operating leases? A. Lease liabilities. B. Future obligations by maturity. C. Net carrying amounts of leased assets.

B. The lessee will disclose the future obligation by maturity of its operating leases. The future obligations by maturity, leased assets, and lease liabilities will all be shown for finance leases.

19. Compared to the provision for income taxes in 2007, the company's cash tax payments were: A. lower. B. higher. C. the same.

B. The net deferred tax liability was smaller in 2007 than it was in 2006, indicating that in addition to meeting the tax payments provided for in 2007 the company also paid taxes that had been deferred in prior periods.

10. A company incurs a capital expenditure that may be amortized over five years for accounting purposes, but over four years for tax purposes. The company will most likely record: A. a deferred tax asset. B. a deferred tax liability. C. no deferred tax asset or liability.

B. The difference is temporary, and the tax base will be lower (because of more rapid amortization) than the carrying value of the asset. The result will be a deferred tax liability.

2. At the time of issue of 4.50% coupon bonds, the effective interest rate was 5.00%. The bonds were most likely issued at: A. par. B. a discount. C. a premium.

B. The effective interest rate is greater than the coupon rate and the bonds will be issued at a discount.

12 - 14 SEE BOOK: 13. The company's effective tax rate was highest in: A. 2005. B. 2006. C. 2007.

B. The effective tax rate of 30.1% ($56,860 / $189,167) was higher than the effective rates in 2005 and 2007.

29 through 35 SEE BOOK: 33. Jordan's response about his approach to estimating a company's need to reinvest in its productive capacity is most likely correct regarding: A. estimating the average age of the asset base. B. estimating the total useful life of the asset base. C. estimating the average remaining useful life of the asset base.

B. The estimated average total useful life of a company's assets is calculated by adding the estimates of the average remaining useful life and the average age of the assets. The average age of the assets is estimated by dividing acc. depreciation by depreciation expense. The average remaining useful life of the asset base is estimated by dividing net property, plant and equipment by annual dep. expense.

22. A company is most likely to: A. use a fair value model for some investment property and a cost model for other investment property. B. change from the fair value model when transactions on comparable properties become less frequent. C. change from the fair value model when the company transfers investment property to property, plant, and equipment.

C. A company will change from the fair value model to either the cost model or the revaluation model when the company transfers investment property to PP&E.

6. The management of Bank EZ repurchases its own bonds in the open market. They pay € 6.5 million for bonds with a face value of € 10.0 million and a carrying value of € 9.8 million. The bank will most likely report: A. other comprehensive income of € 3.3 million. B. other comprehensive income of € 3.5 million. C. a gain of € 3.3 million on the income statement.

C. A gain of € 3.3 million (carrying amount less amount paid) will be reported on the income statement.

20 - 22 SEE BOOK: 21. The $ 357,000 adjustment in 2007 most likely resulted in: A. an increase in deferred tax assets. B. an increase in deferred tax liabilities. C. no change to deferred tax assets and liabilities.

C. Accounting expenses that are not deductible for tax purposes result in a permanent difference, and thus do not give rise to deferred taxes.

7. When accounting standards require recognition of an expense that is not permitted under tax laws, the result is a: A. deferred tax liability. B. temporary difference. C. permanent difference.

C. Accounting items that are not deductible for tax purposes will not be reversed and thus result in permanent differences.

4. Intangible assets with finite useful lives mostly differ from intangible assets with infinite useful lives with respect to accounting treatment of: A. revaluation. B. impairment. C. amortization.

C. An intangible asset with a finite useful life is amortized, whereas an intangible asset with an indefinite useful life is not.

CHAPTER 13: 1. Using the straight-line method of depreciation for reporting purposes and accelerated depreciation for tax purposes would most likely result in a: A. valuation allowance. B. deferred tax asset. C. temporary difference.

C. Because the differences between tax and financial accounting will correct over time, the resulting deferred tax liability, for which the expense was charged to the income statement but the tax authority has not yet been paid, will be a temporary difference. A valuation allowance would only arise if there was doubt over the company's ability to earn sufficient income in the future to require paying the tax.

9. Debt covenants are least likely to place restrictions on the issuer's ability to: A. pay dividends. B. issue additional debt. C. issue additional equity.

C. Covenants protect debtholders from excessive risk taking, typically by limiting the issuer's ability to use cash or by limiting the overall levels of debt relative to income and equity. Issuing additional equity would increase the company's ability to meet its obligations, so debtholders would not restrict that ability.

23 - 28 SEE BOOK: 23. With respect to Statement 1, which of the following is the most likely effect of management's decision to expense rather than capitalize these expenditures? A. 2009 net profit margin is higher than if the expenditures had been capitalized. B. 2009 total asset turnover is lower than if the expenditures had been capitalized. C. Future profit growth will be higher than if the expenditures had been capitalized.

C. Expensing rather than capitalizing an investment in long-term assets will result in higher expenses and lower net income and net profit margin in the current year. Future years' income will not include depreciation expense related to these expenditures. Consequently, year-to-year growth in profitability will be higher. If the expenses had been capitalized, the carrying amount of the assets would have been higher and the 2009 total asset turnover would have been lower.

3. Income tax expense reported on a company's income statement equals taxes payable, plus the net increase in: A. deferred tax assets and deferred tax liabilities. B. deferred tax assets, less the net increase in deferred tax liabilities. C. deferred tax liabilities, less the net increase in deferred tax assets.

C. Higher reported tax expense relative to taxes paid will increase the deferred tax liability, whereas the lower reported tax expense relative to taxes paid increases the deferred tax asset.

6. Juan Martinez, CFO of VIRMIN, S.A., is selecting the depreciation method to use for a new machine. The machine has an expected useful life of six years. Production is expected to be relatively low initially but to increase over time. The method chosen for tax reporting must be the same as the method used for financial reporting. If Martinez wants to minimize tax payments in the first year of the machine's life, which of the following depreciation methods is Martinez most likely to use? A. Straight-line method B. Units-of-production method C. Double-declining balance method

C. If Martinez wants to minimize tax payments in the first year of the machine's life, he should use an accelerated method, such as the double-declining balance method.

23 - 28 SEE BOOK: 24. With respect to Statement 2, what would be the most likely effect in 2010 if AMRC were to switch to an accelerated depreciation method for both financial and tax reporting? A. Net profit margin would decrease. B. Total asset turnover would increase. C. Cash flow from operating activities would increase.

C. In 2010, switching to an accelerated depreciation method would increase depreciation expense and decrease income before taxes, taxes payable, and net income. Cash flow from operating activities would increase because of the resulting tax savings.

8. When certain expenditures result in tax credits that directly reduce taxes, the company will most likely record: A. a deferred tax asset. B. a deferred tax liability. C. no deferred tax asset or liability.

C. Tax credits that directly reduce taxes are a permanent difference, and permanent differences do not give rise to deferred tax.

29 through 35 SEE BOOK: 31. Jordan's response about the impact of Alpha's decision to classify its lease as an operating lease instead of finance lease is most likely incorrect with respect to: A. net income. B. solvency and activity ratios. C. cash flow from operating activities.

C. The cash flow from operating activities will be lower, not higher, because the full lease payment is treated as operating cash outflow. With a finance lease, only the portion of the lease payment relating to interest expense potentially reduces operating cash outflows. A company reporting a lease as an operating lease will typically show higher profits in early years, because the lease expense is less than the sum of the interest and depreciation expense. The company with operating lease will typically report stronger solvency and activity ratios.

15. Cavalier Copper Mines has $ 840 million in total liabilities and $ 520 million in shareholders' equity. It discloses operating lease commitments over the next five years with a present value of $ 100 million. If the lease commitments are treated as debt, the debt-to-total-capital ratio is closest to: A. 0.58. B. 0.62. C. 0.64.

C. The current debt-to-total-capital ration is $840 / ($840 + $520) = .62. To adjust for the lease commitments, an analyst should add $100 to both the numerator and denominator: $940 / ($940 + $520) = .64.

10. Which of the following will cause a company to show a lower amount of amortization of intangible assets in the first year after acquisition? A. A higher residual value B. A higher amortization rate C. A shorter useful life

A. A higher residual value results in a lower total depreciable cost and, therefore, a lower amount of amortization in the first year after acquisition (and every year after that).

17 - 19 SEE BOOK: 17. A reduction in the statutory tax rate would most likely benefit the company's: A. income statement and balance sheet. B. income statement but not the balance sheet. C. balance sheet but not the income statement.

A. A lower tax rate would increase net income on the income statement, and because the company has a net deferred tax liability, the net liability position on the balance sheet would also improve (be smaller).

14. A lessor will record interest income if a lease is classified as: A. a capital lease. B. an operating lease. C. either a capital or an operating lease.

A. A portion of the payments for capital leases, either direct financing or sales-type, is reported as interest income. With an operating lease, all revenue is recorded as rental revenue.

2. BAURU, S.A., a Brazilian corporation, borrows capital from a local bank to finance the construction of its manufacturing plant. The loan has the following conditions: Borrowing date - 1 January 2009 Amount borrowed - 500 million Brazilian real (BRL) Annual interest rate - 14 percent Term of the loan - 3 years Payment method - Annual payment of interest only. Principal amortization is due at the end of the loan term. The construction of the plant takes two years, during which time BAURU earned BRL 10 million by temporarily investing the loan proceeds. Which of the following is the amount of interest related to the plant construction (in BRL million) that can be capitalized in BAURU's balance sheet? A. 130 B. 140 C. 210

A. Borrowing costs can be capitalized under IFRS until the tangible asset is ready for use. Also, under IFRS, income earned on temporarily investing the borrowed monies decreases the amount of borrowing costs eligible for capitalization. Therefore, total capitalized interest = (500 million X 14% X 2 years) - 10 million = 130 million.

16. CROCO S.p.A. sells an intangible asset with a historical acquisition cost of € 12 million and an accumulated depreciation of € 2 million and reports a loss on the sale of € 3.2 million. Which of the following amounts is most likely the sale price of the asset? A. € 6.8 million B. € 8.8 million C. € 13.2 million

A. Gain or loss on sale = Sale Proceeds - Carrying amount. Rearranging this equation, Sale Proceeds = Carrying amount + Gain or loss on sale. Thus, sale price = (12 million - 2 million) + (-3.2 million) = 6.8 million.

18. According to IFRS, all of the following pieces of information about intangible assets must be disclosed in a company's financial statements and footnotes except for: A. fair value. B. impairment loss. C. amortization rate.

A. IFRS do not require fair value of intangible assets to be disclosed.

5. A financial analyst is studying the income statement effect of two alternative depreciation methods for a recently acquired piece of equipment. She gathers the following information about the equipment's expected production life and use: Year 1 2 3 4 5 Total Units of production 2,000 2,000 2,000 2,000 2,500 10,500 Compared with the units-of-production method of depreciation, if the company uses the straight-line method to depreciate the equipment, its net income in Year 1 will most likely be: A. lower. B. higher. C. the same.

A. If the company uses the straight-line method, the depreciation expense will be one-fifth (20%) of the depreciable cost in Year 1. If it uses the units-of-production method, the depreciation expense will be 19% (2,000/10,500) of the depreciable cost in Year 1. Therefore, if the company uses the straight-line method, its depreciation expense willbe higher and its net income will be lower.

5. Deferred tax liabilities should be treated as equity when: A. they are not expected to reverse. B. the timing of tax payments is uncertain. C. the amount of tax payments is uncertain.

A. If the liability will not reverse, there will be no required tax payment in the future and the "liability" should be treated as equity.

12 - 14 SEE BOOK: 14. Compared to the company's effective tax rate on US income, its effective tax rate on foreign income was: A. lower in each year presented. B. higher in each year presented. C. higher in some periods and lower in others.

A. In 2007, the effective tax rate on foreign opperations was 24.2% [($28,140 + $124) / $116,704] and the effective US Tax rate was [($30,632 - $4,752) / $88,157] = 29.4%. In 2006 the effective tax rate on foreign operations was 26.2% and the US rate was 35.9%. In 2005 the foreign rate was 24.1% and the US rate was 35.5%.

29 through 35 SEE BOOK: 35. Jordan's response about the effect of Alpha's revaluation is most likely correct with respect to the impact on its: A. return on equity. B. return on assets. C. debt to capital ratio.

A. In an asset revaluation, the carrying amount of the assets increases. The increase in the asset's carrying amount bypass the income statement and is reported as other comprehensive income and appears in equity under the heading of revaluation surplus. Therefore, shareholders' equity will increase but net income will not be affected, so ROE will decrease & ROA & debt-to-capital ratios.

21. Investment property is most likely to: A. earn rent. B. be held for resale. C. be used in the production of goods and services.

A. Investment property earns rent. Inventory is held for resale, and PP&E are used in production of goods and services.

11. A company receives advance payments from customers that are immediately taxable but will not be recognized for accounting purposes until the company fulfills its obligation. The company will most likely record: A. a deferred tax asset. B. a deferred tax liability. C. no deferred tax asset or liability.

A. The advances represent a liability for the company. The carrying value of the liability exceeds the tax base (which is now 0). A deferred tax asset arises when the carrying value of a liability exceeds its tax base.

9. When accounting standards require an asset to be expensed immediately but tax rules require the item to be capitalized and amortized, the company will most likely record: A. a deferred tax asset. B. a deferred tax liability. C. no deferred tax asset or liability.

A. The capitalization will result in an asset with a positive tax base and zero carrying value. the amortization means the difference is temporary. Because there is a temporary difference on an asset resulting in a higher tax base than carrying value, a deferred tax asset is created.

5. Consolidated Enterprises issues € 10 million face value, five-year bonds with a coupon rate of 6.5 percent. At the time of issuance, the market interest rate is 6.0 percent. Using the effective interest rate method of amortization, the carrying value after one year will be closest to: A. € 10.17 million. B. € 10.21 million. C. € 10.28 million.

A. The coupon rate on the bonds is higher than the market rate, which indicates that the bonds will be issued at premium. Taking the present value of each payment indicates an issue data value of € 10,210,618. The interest expense is determined by multiplying the carrying amount at the beginning of the period (€ 10,210,618) by the market interest rate at the time of issue (6%) for an interest expense of € 612,637. The value after one year will equal the beginning value less the amount of the premium amortized to date, which is the difference between the amount paid (€650,000) and the expense accrued (€612,637) or € 37,363. € 10,210,618 - € 37,363 = € 10,173,255 or € 10.17 million.

7. Innovative Inventions, Inc. needs to raise € 10 million. If the company chooses to issue zero-coupon bonds, its debt-to-equity ratio will most likely: A. rise as the maturity date approaches. B. decline as the maturity date approaches. C. remain constant throughout the life of the bond.

A. The value of the liability for zero-coupon bonds increases as the discount is amortized over time. Furthermore, the amortized interest will reduce earnings at an increasing rate over time as the value of the liability increases. Higher relative debt and lower relative equity (through retained earnings) will cause the debt-to-equity ratio to increase as the zero-coupon bonds approach maturity.

3. Oil Exploration LLC paid $ 45,000 in printing, legal fees, commissions, and other costs associated with its recent bond issue. It is most likely to record these costs on its financial statements as: A. an asset under US GAAP and reduction of the carrying value of the debt under IFRS. B. a liability under US GAAP and reduction of the carrying value of the debt under IFRS. C. a cash outflow from investing activities under both US GAAP and IFRS.

A. Under US GAAP, expenses incurred when issuing bonds are generallt recorded as an asset and amortized to the related expense (legal, etc.) over the life of the bonds. Under IFRS, they are included in the measurement of the liability. The related cash flows are financing activities.

7. Miguel Rodriguez of MARIO, S.A., an Uruguayan corporation, is computing the depreciation expense of a piece of manufacturing equipment for the fiscal year ended 31 December 2009. The equipment was acquired on 1 January 2009. Rodriguez gathers the following information (currency in Uruguayan pesos, UYP): Cost of the equipment UYP - 1,200,000 Estimated residual value UYP - 200,000 Expected useful life - 8 years Total productive capacity - 800,000 units Production in FY 2009 - 135,000 units Expected production (next 7 years) - 95,000 units each year If MARIO uses the straight-line method, the amount of depreciation expense on MARIO's income statement related to the manufacturing equipment is closest to: A. 125,000. B. 150,000. C. 168,750.

A. Using the straight-line method, depreciation expense amounts to (1,200,000 - 200,000) /8 years = 125,000.

8. Fairmont Golf issued fixed rate debt when interest rates were 6 percent. Rates have since risen to 7 percent. Using only the carrying amount (based on historical cost) reported on the balance sheet to analyze the company's financial position would most likely cause an analyst to: A. overestimate Fairmont's economic liabilities. B. underestimate Fairmont's economic liabilities. C. underestimate Fairmont's interest coverage ratio.

A. When interest rates rise, bonds decline in value. Thus, the carrying amount of the bonds being carried on the balance sheet is higher than the market value. The company could repurchases the bonds for less than the carrying amount, so the economic liabilities are overestimated. Because the bonds are issued at a fixed rate, there is no effect on interest coverage.

23 - 28 SEE BOOK: 27. With respect to Statement 4, if AMRC had used its old classification method for its leases instead of its new classification method, its 2009 total asset turnover ratio would most likely be: A. lower. B. higher. C. the same.

A. When leases are classified as finance leases, the lessee initially reports an asset and liability at a carrying amount equal to the lower of the fair value of the leased asset or the present value of the future lease payments. Under an operating lease, the lessee does not report an asset or liability. Therefore, total asset turnover (Total revenue / Average total assets) would be lower if the leases we classified as finance leases.

23 - 28 SEE BOOK: 25. With respect to Statement 3, what is the most likely effect of the impairment loss? A. Net income in years prior to 2009 was likely understated. B. Net profit margins in years after 2009 will likely exceed the 2009 net profit margin. C. Cash flow from operating activities in 2009 was likely lower due to the impairment loss.

B. 2009 net income and net profit margin are lower because of the impairment loss. Consequently, net profit margins in subsequent years are likely to be higher. An impairment loss suggests that insufficient depreciation expense was recognized in prior years, and net income was overstated in prior years. The impairment loss is a non-cash item and will not affect operating cash flows.

3. After reading the financial statements and footnotes of a company that follows IFRS, an analyst identified the following intangible assets: product patent expiring in 40 years copyright with no expiration date goodwill acquired 2 years ago in a business combination Which of these assets is an intangible asset with a finite useful life? Product Patent Copyright Goodwill A. Yes Yes No B. Yes No No C. No Yes Yes

B. A product patent with a defined expiration date is an intangible asset with a finite useful life. A copyright with no expiration data is an intangible asset with and indefinite useful life. Goodwill is no longer considered an intangible asset under IFrS and is consdiered to have an indefinite useful life.

29 through 35 SEE BOOK: 30. Jordan's response about the ratio impact of Alpha's decision to capitalize interest costs is most likely correct with respect to the: A. interest coverage ratio. B. fixed asset turnover ratio. C. interest coverage and fixed asset turnover ratios.

B. Alpha's fixed asset turnover will be lower because the capitalized interest will appear on the balance sheet as part of the asset being constructed. Therefore, fixed assets will be higher and the fixed asset turnover ratio (Total revenue / Average net fixed assets) will be lower than is it had expensed these costs. Capitalized interest appears on the balance sheet as part of the asset being constructed instead of being reported as interest expense in the period incurred. However, the interest coverage ratio should be based on interest payments, not interest expense (Earning before interest and taxes / Interest payments), and should be unchanged. To provide a true picture of a company's interest coverage, the entire amount of interest expenditure, both the capitalized portion and the expensed portion, should be used in calculating interest coverage ratio.

10. Compared to using a finance lease, a lessee that makes use of an operating lease will most likely report higher: A. debt. B. rent expense. C. cash flow from operating activity.

B. An operating lease is not recorded on the balance sheet (debt is lower), and lease payments are entirely categorized as rent (interest expense is lower). Because the rent expense is an operating outflow but the principal repayments are financing cash flows, the operating lease will result in lower cash flow from operating activity.

17. According to IFRS, all of the following pieces of information about property, plant, and equipment must be disclosed in a company's financial statements and footnotes except for: A. useful lives. B. acquisition dates. C. amount of disposals.

B. IFRS do not require acquisition dates to be disclosed.

4. Analysts should treat deferred tax liabilities that are expected to reverse as: A. equity. B. liabilities. C. neither liabilities nor equity.

B. If the liability is expected to reverse (and thus require a cash tax payment) the deferred tax represents a future liability.

13. MARU S.A. de C.V., a Mexican corporation that follows IFRS, has elected to use the revaluation model for its property, plant, and equipment. One of MARU's machines was purchased for 2,500,000 Mexican pesos (MXN) at the beginning of the fiscal year ended 31 March 2010. As of 31 March 2010, the machine has a fair value of MXN 3,000,000. Should MARU show a profit for the revaluation of the machine? A. Yes. B. No, because this revaluation is recorded directly in equity. C. No, because value increases resulting from revaluation can never be recognized as a profit.

B. In this case, the value increase brought about by the revaluation should be recorded directly in equity. The reason is that under IFRS, an increase in value brought about by a revaluation can only be recognized as a profit to the extent that is reverse a revaluation decrease of the same asset previously recognized in the income statement.

19. Which of the following characteristics is most likely to differentiate investment property from property, plant, and equipment? A. It is tangible. B. It earns rent. C. It is long-lived.

B. Investment property earns rent. investment property and property, plant, and equipment are tangible and long-lived.

CHAPTER 9: 1. JOOVI Inc. has recently purchased and installed a new machine for its manufacturing plant. The company incurred the following costs: Purchase price - $ 12,980 Freight and insurance - $ 1,200 Installation - $ 700 Testing - $ 100 Maintenance staff training costs - $ 500 The total cost of the machine to be shown on JOOVI's balance sheet is closest to: A. $ 14,180 B. $ 14,980 C. $ 15,480.

B. Only costs necessary for the machine to be ready to use can be capitalized. Therefore, total capitalized costs = 12,980 + 1,200 + 700 + 100 = $14,980.

20 - 22 SEE BOOK: 22. Over the three years presented, changes in the valuation allowance for deferred tax assets were most likely indicative of: A. decreased prospect for future profitability. B. increased prospects for future profitability. C. assets being carried at a higher value than their tax base.

B. Over the three-year period, changes in the valuation allowance reduced cumulative income taxes by $1,670,000. The reduction to the valuation allowance were a result of the company being "more likely than not" to earn sufficient taxable income to offset the deferred tax assets.

4. On 1 January 2010, Elegant Fragrances Company issues £ 1,000,000 face value, five-year bonds with annual interest payments of £ 55,000 to be paid each 31 December. The market interest rate is 6.0 percent. Using the effective interest rate method of amortisation, Elegant Fragrances is most likely to record: A. an interest expense of £ 55,000 on its 2010 income statement. B. a liability of £ 982,674 on the 31 December 2010 balance sheet. C. a £ 58,736 cash outflow from operating activity on the 2010 statement of cash flows.

B. The bonds will be issued at a discount because the market interest rate is higher than the stated rate. Discounting future payments to their present value indicates that at the time of issue, the company will record £978,938 as both a liability and a cash inflow from financing. Interest expense in 2010 is £58,736 (£978,938 * .6). During the year, the company will pay cash of £55,000 related to the interest payment, but interest expense on the income statement will also reflect £3,736 related to amortization of the initial discount (£58,736 interest expense - £55,000 interest payment). Thus, the value of the liability at 31 Dec 2010 will reflect the initial value (£978,938) plus the amortized discount (£3,736), for a total of £982,674. The cash outflow of £55,000 must be presented as either an operating or financing activity under IFRS.

CHAPTER 10: 1. A company issues € 1 million of bonds at face value. When the bonds are issued, the company will record a: A. cash inflow from investing activities. B. cash inflow from financing activities. C. cash inflow from operating activities.

B. The company receives € 1 million in cash from investors at the time the bonds are issued, which is recorded as a financing activity.

16. Penben Corporation has a defined benefit pension plan. At 31 December, its pension obligation is € 10 million and pension assets are € 9 million. Under either IFRS or US GAAP, the reporting on the balance sheet would be closest to which of the following? A. € 10 million is shown as a liability, and € 9 million appears as an asset. B. € 1 million is shown as a net pension obligation. C. Pension assets and obligations are not required to be shown on the balance sheet but only disclosed in footnotes.

B. The company will report a net pension obligation of € 1 million equal to pension obligation (€ 10 million) less the plan assets (€ 9 million).

15. A financial analyst at BETTO, S.A. is analyzing the result of the sale of a vehicle for 85,000 Argentine pesos (ARP) on 31 December 2009. The analyst compiles the following information about the vehicle: Acquisition cost of the vehicle ARP - 100,000 Acquisition date - 1 January 2007 Estimated residual value at acquisition date ARP - 10,000 Expected useful life - 9 years Depreciation method - Straight-line The result of the sale of the vehicle is most likely: A. a loss of ARP 15,000. B. a gain of ARP 15,000. C. a gain of ARP 18,333.

B. The result on the sale of the vehicle equals gain(loss) on sale: = sale proceeds - carrying amount =Sale Proceeds - (Acquisition cost - Acc. Dep.) = 85,000 - {100,000- [((100,000-10,000)/9) X 3]} = 15,000

15. Zimt AG presents its financial statements in accordance with US GAAP. In 2007, Zimt discloses a valuation allowance of $ 1,101 against total deferred tax assets of $ 19,201. In 2006, Zimt disclosed a valuation allowance of $ 1,325 against total deferred tax assets of $ 17,325. The change in the valuation allowance most likely indicates that Zimt's: A. deferred tax liabilities were reduced in 2007. B. expectations of future earning power has increased. C. expectations of future earning power has decreased.

B. The valuation allowance is taken against the deferred tax assets to represent uncertainty that future taxable income will be sufficient to fully utilize the assets. By decreasing the allowance, Zimt is signaling greater liklihood that future earnings will be offset by the deferred tax asset.

11. An analyst in the finance department of BOOLDO, S.A., a French corporation, is computing the amortization of a customer list, an intangible asset, for the fiscal year ended 31 December 2009. She gathers the following information about the asset: Acquisition cost - € 2,300,000 Acquisition date - 1 January 2008 Expected residual value at time of acquisition - € 500,000 The customer list is expected to result in extra sales for three years after acquisition. The present value of these expected extra sales exceeds the cost of the list. If the analyst uses the straight-line method, the amount of accumulated amortization related to the customer list as of 31 December 2009 is closest to: A. € 600,000. B. € 1,200,000. C. € 1,533,333.

B. Using the straight-line method, accumulated amortization amounts to [(2,300,000 - 500,000) / 3 years] X 2 years = 1,200,000.

8. If MARIO uses the units-of-production method, the amount of depreciation expense (in UYP) on MARIO's income statement related to the manufacturing equipment is closest to: A. 118,750. B. 168,750. C. 202,500.

B. Using the units-of-production method, depreciation expense amounts to (1,200,000 - 200,000) X (135,000/800,000) = 168,750.

12. A financial analyst is analyzing the amortization of a product patent acquired by MAKETTI S.p.A., an Italian corporation. He gathers the following information about the patent: Acquisition cost - € 5,800,000 Acquisition date - 1 January 2009 Patent expiration date - 31 December 2015 Total plant capacity (patented product) 40,000 units / year Prod. (patented product, yr ended Dec 2009) - 20,000 units Expected production during life - 175,000 units If the analyst uses the units-of-production method, the amortization expense on the patent for fiscal year 2009 is closest to: A. € 414,286. B. € 662,857. C. € 828,571.

B. Using the units-of-production method, depreciation expense amounts to 5,8000,000 X (20,000 / 175,000) = 662,857.

12. For a lessor, the leased asset appears on the balance sheet and continues to be depreciated when the lease is classified as: A. a sales-type lease. B. an operating lease. C. a financing lease.

B. When a lease is classified as an operating lease, the underlying asset remains on the lessor's balance sheet. THe lessor will record a depreciation expense that reduces the asset's value over time.

29 through 35 SEE BOOK: 29. Jordan's response about the financial statement impact of Alpha's decision to capitalize the cost of its new computer system is most likely correct with respect to: A. lower net income. B. lower total assets. C. higher cash flow from operating activities.

C. The decision to capitalize costs of the new computer system results in higher cash flow from operating activities; the expenditure is reported as an outflow of investing activities. The company allocates the capitalized amount over the asset's useful life as depreciation or amortized expense rather than expensing it in the year of expenditure. Net income and total assets are higher in the current fiscal year.

6. When both the timing and amount of tax payments are uncertain, analysts should treat deferred tax liabilities as: A. equity. B. liabilities. C. neither liabilities nor equity.

C. The deferred tax liability should be excluded from both debt and equity when both amounts and timing of tax payments resulting from the reversals of temporary differences are uncertain.

29 through 35 SEE BOOK: 34. Jordan's response about the effect of Beta's impairment loss is most likely incorrect with respect to the impact on its: A. debt to total assets. B. fixed asset turnover. C. cash flow from operating activities.

C. The impairment loss is a non-cash charge and will not affect cash flow from operating activities. The debt to total assets and fixed asset turnover ratios will increase, because the impairment loss will reduce the carrying amount of fixed assets and therefore total assets.

20 - 22 SEE BOOK: 20. In 2007, the company's net income (loss) was closest to: A. ($ 217,000). B. ($ 329,000). C. ($ 556,000).

C. The income tax provision at the statutory rate of 34% is a benefit of $112,000, suggesting that the pre-tax income was a loss of $112,000 / .34 = ($329,412). The income tax provision was $227,000. ($329,412) - $227,000 = ($556,412).

17 - 19 SEE BOOK: 18. If the valuation allowance had been the same in 2007 as it was in 2006, the company would have reported $ 115 higher: A. net income. B. deferred tax assets. C. income tax expense.

C. The reduction in the valuation allowance resulted in a corresponding reduction in the income tax provision.

23 - 28 SEE BOOK: 28. With respect to Statement 4 and Exhibit A, if AMRC had used its old classification method for its leases instead of its new classification method, the most likely effect on its 2009 ratios would be a: A. higher net profit margin. B. higher fixed asset turnover. C. higher total liabilities-to-total assets ratio.

C. Total liabilities-to-assets would be higher. When leases are classfied as finance leases, the leassee initially reports an asset and liability at a carrying amount equal to the lower of the fair value of the leases asset or the present value of the future lease payments. Both the numerator and denominator would increase by an equal amount, but the proportional increase in the numerator is higher and the ratio would be higher. The following exhibit shows what would happen to 2009 total liabilities, assets, and total liabilities-to-assets if 200 million, the fair value of the leased equipment, is added to AMRC's total liabilities and assets. The simple example ignores the impact of accounting for the 2009 lease payment. 2009 Actual (Op.) 2009 Hypothetical (Cap.) Ttl Liab. 2750 2950 Ttl Assets 5350 5550 Ttl L-to-A 51.4% 53.2% The depreciation and interest expense under a finance lease tends to be higher than the operating lease payments in the early years of the lease. The finance lease would result in lower net income and net profit margin. Long-lived (fixed) assets are higher under a finance lease and fixed asset turnover is lower.

20. If a company uses the fair value model to value investment property, changes in the fair value of the asset are least likely to affect: A. net income. B. net operating income. C. other comprehensive income.

C. when a company uses the fair value model to value investment property, changes in fair value of the property are reported in the income statement- not in other comprehensive income.

16. Cinnamon, Inc. recorded a total deferred tax asset in 2007 of $ 12,301, offset by a $ 12,301 valuation allowance. Cinnamon most likely: A. fully utilized the deferred tax asset in 2007. B. has an equal amount of deferred tax assets and deferred tax liabilities. C. expects not to earn any taxable income before the deferred tax asset expires.

C.The valuation allowance is taken when the company will "more likely than not" fail to earn sufficient income to offset the deferred tax asset. Because the valuation allowance equals the asset, by extension the company expects NO taxable income prior to the expiration of the deferred tax assets.