FIN 350 pt 2

Analysis of Fixed Assets

-Analysts can use financial statement disclosures to estimate the average age of fixed assets and the average remaining useful life -Identify: • Firms with older, inefficient assets (may imply less production efficiency • Need for major capital investments -Estimated Average Age of Equipment= Accumulated Depreciation / Annual Depreciation Expense -Estimated Remaining Useful Life= Net PP&E / Annual Depreciation Expense -Estimated Total Useful Life= Historical Cost / Annual Depreciation Expense

True regarding the LIFO reserve

-Companies using LIFO are required to report the LIFO reserve to enable analysts make adjustments to their financial statements. -The financial statement differences of using LIFO normally increase the longer a company uses LIFO and if prices have changed during the period. (Compared to a firm using FIFO).

Capitalizing vs. Expensing (continued)

-Income Statement Effect (See example 4, p. 349): •Capitalizing firms have more stable income growth patterns, expensing firms have greater variance of reported earnings (fluctuating income growth) •In early years, capitalizing firms have higher profitability expensing firms have lower profitability. Reverses in later years •In later years, capitalizing firms have lower profitability, expensing firms have higher profitability •Expensing enhances the profit trend •Profitability-enhancing effect of capitalizing continues as long as CAPEX exceeds depreciation expense

Capitalizing vs. Expensing

-We will compare what happens if management capitalizes or expenses a long-lived asset •Choice can result in smoothing or manipulation of reported income, cash flows and other performance measures; Affects the balance sheet assets as well -The matching principle states that if an asset contributes to generating revenues over a number of periods, we should spread the cost of the asset over its useful life •Capitalize the asset (Record it on the Balance Sheet) •Report depreciation expense in income statement each period •If an asset has no impact (or has highly uncertain impact) on future earnings, it should be expensed

Intangible Assets continued

-When intangible assets are developed internally (R&D), there is a higher degree of management discretion with respect to measurement •Costs incurred in developing these may not be easily separated or identified •Costs generally expensed when incurred •Classified as operating cash flows on the Cash Flow Statement •No balance sheet recognition of resulting asset -IFRS: Expenditures during research phase are expensed, development phase is capitalized -US GAAP: Both research and development costs are expensed •Exception: Software development. Expense costs until feasibility is established then capitalize •Capitalized costs include costs of employees who help build and test the software

R&D capitalization

-after research is completed and the development begins, the development gets capitalized and is then considered an asset on the balance sheet -expense during research phase, capitalize during development phase

Intangible assets with finite useful lives mostly differ from intangible assets with infinite useful lives with respect to accounting treatment of:

Impairment

Costs incurred for intangible assets are generally expensed when they are:

Internally developed

The interest expense reported on the income statement in the first year assuming the firm uses the effective interest rate method is closest to:

$146,565

A firm recently disposed of machinery it used in its manufacturing operations. It recognized a $15,000 loss on the sale of the machinery. The original cost of the machinery was $100,000 and its accumulated depreciation at the date of sale was $60,000. How much cash did the firm receive from the sale?

$25,000

The bonds payable reported on the balance sheet at the time of issuance is closest to:

$4,885,507

The carrying value minus the tax base of the asset at the end of year 1 is:

+$10,000

Income taxes

-Objective of Financial Reporting is to provide users with information needed to evaluate a firm's financial position, performance and cash flows •Adoption of various GAAP and IFRS conventions allows firms to best match revenues with expenses -Tax Reporting is a result of social and political influences -Revenue and Expense recognition methods used in tax reporting often differ from those used for financial reporting

Remeasurements include:

-actuarial gains and losses -the actual return on plan asset less any return included in the net interest expense or income

DTL's as a result of temporary differences will be recognized unless both of the following criteria are met:

-the parent is in a position to control the timing of the future reversal of the temporary difference -it is probable that the temporary difference will not reverse in the future

Bonds contain promises of two types of future cash payments:

1. face value of the bond 2. periodic interest payments

Taxable income in year 1 is:

10,000

If MARIO uses the straight-line method, the amount of depreciation expense on MARIO's income statement related to the manufacturing equipment is clos- est to:

125,000

Based on Exhibits 1 and 2, the best estimate of the average remaining useful life of the company's plant and equipment at the end of 2009 is:

20.75 years

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

A is correct. 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.

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

A is correct. A sales-type lease treats the lease as a sale of the asset, and revenue is recorded at the time of sale 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 from rent is reported when collected.

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

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

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 deferred tax asset. a deferred tax liability. no deferred tax asset or liability.

A is correct. 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.

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: taxes payable. income tax expense. a deferred tax liability.

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

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: overestimate Fairmont's economic liabilities. underestimate Fairmont's economic liabilities. underestimate Fairmont's interest coverage ratio.

A is correct. 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 repurchase 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.

Which of the following does not result in a deferred tax item?

A permanent difference between tax reporting and financial reporting.

Which of the following is most likely to be considered a potential benefit of accounting conservatism?

A reduction in litigation costs.*

valuation allowance

A reserve created against deferred tax assets -based on the likelihood of realizing the deferred tax assets in future accounting periods.

An audit opinion of a company's financial reports is most likely intended to:

Assure that financial information is presented fairly.

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

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

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: other comprehensive income of €3.3 million. other comprehensive income of €3.5 million. a gain of €3.3 million on the income statement.

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

Low quality earnings most likely reflect:

Company activities which are unsustainable.

An analyst reviewing a firm with a large, current-period restructuring charge to earnings should:

Consider making pro forma adjustments to prior years' earnings.

Which of the following is an indication that a company may be recognizing revenue prematurely? Relative to its competitors, the company's:

Days sales outstanding is increasing.*

Balance Sheet Item: Asset Carrying Amount < Tax Base

Deferred Tax Asset

Interest Coverage Ratio

EBIT/ interest expense

Which of the following is a required financial statement disclosure for long- lived intangible assets under US GAAP?

Estimated amortization expense for the next five fiscal years

With respect to Statement 1, which of the following is the most likely effect of management's decision to expense rather than capitalise these expenditures?

Future profit growth will be higher than if the expenditures had been capitalised.

To properly assess a company's past performance, an analyst requires:

High financial reporting quality.*

Which attribute of financial reports would most likely be evaluated as optimal in the financial reporting spectrum?

Sustainable and adequate returns.

Jordan's response about the impact of the different depreciation methods on net profit margin is most likely incorrect with respect to:

accelerated depreciation

carrying amount

amount at which the asset or liability is valued according to accounting principles -differences in tax base and carrying amount also result in differences between accounting profit and taxable income

Tax Base

amount at which the asset or liability is valued for tax purposes

Tax expense

an aggregate of a company's income tax payable and any changes in deferred tax assets and liabilities

The impairment of intangible assets with finite lives affects:

both the balance sheet and the income statement.

income tax payable

calculated on the basis of the company's tax rate and appears on it B/S

At the end of year 1, the firm's financial reporting balance sheet will report a:

deferred tax liability of $4,000.

Neither DTA's nor DTL's are ________ to present value in determining the amounts to be booked

discounted

Investment property is most likely to:

earn rent

Under the revaluation model for property, plant, and equipment and the fair model for investment property:

fair value of the asset must be able to be measured reliably.

Jordan's response about the ratio impact of Alpha's decision to capitalise inter- est costs is most likely correct with respect to the:

fixed asset turnover ratio

Leverage ratios

focus on the balance sheet and measure the extent to which a company uses liabilities rather than equity to finance its assets

Reported Effective Tax Rate

income tax expense / pretax income (accounting profit)

As time elapses and the bonds get closer and closer to maturity, the bonds payable for the firm reported on the balance sheet will:

increase

US GAAP requires companies to classify interest paid as...

operating activity

IFRS allows companies to classify interest paid within...

operating, investing, or financing activities

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:

other comprehensive income

accounting profit

reported on I/S in accordance with prevailing accounting standards

finance lease

similar to purchasing an asset

operating lease

similar to renting an asset

Difference between interest expense and interest payment

the amortization of the discount or premium

Face Value of Bonds

the amount of cash payable by the company to he bondholders when the bonds mature

The total interest expense reflects both components of the borrowing cost: (premium)

the periodic interest payments less the amortization of the premium

A company is comparing straight-line and double-declining balance amortiza- tion methods for a non-renewable six-year license, acquired for €600,000. The difference between the Year 4 ending net book values using the two methods is closest to:

€81,400.

Which of the following will cause a company to show a lower amount of amor- tization of intangible assets in the first year after acquisition?

A higher residual value

Carrying inventory at a value above its historical cost would most likely be permitted if: the inventory was held by a producer of agricultural products. financial statements were prepared using US GAAP. the change resulted from a reversal of a previous write-down.

A is correct. IFRS allow the inventories of producers and dealers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products to be carried at net realisable value even if above historical cost. (US GAAP treatment is similar.)

Fernando's Pasta purchased inventory and later wrote it down. The current net realisable value is higher than the value when written down. Fernando's inventory balance will most likely be: higher if it complies with IFRS. higher if it complies with US GAAP. the same under US GAAP and IFRS.

A is correct. IFRS require the reversal of inventory write-downs if net realisable values increase; US GAAP do not permit the reversal of write-downs.

Carey Company adheres to US GAAP, whereas Jonathan Company adheres to IFRS. It is least likely that: Carey has reversed an inventory write-down Jonathan has reversed an inventory write-down. Jonathan and Carey both use the FIFO inventory accounting method.

A is correct. US GAAP do not permit inventory write-downs to be reversed.

Zimt AG uses the FIFO method, and Nutmeg Inc. uses the LIFO method. Compared to the cost of replacing the inventory, during periods of rising prices, the cost of sales reported by: Zimt is too low. Nutmeg is too low. Nutmeg is too high.

A is correct. Zimt uses the FIFO method, so its cost of sales represents units purchased at a (no longer available) lower price. Nutmeg uses the LIFO method, so its cost of sales is approximately equal to the current replacement cost of inventory.

Zimt AG uses the FIFO method, and Nutmeg Inc. uses the LIFO method. Compared to the cost of replacing the inventory, during periods of rising prices the ending inventory balance reported by: Zimt is too high. Nutmeg is too low. Nutmeg is too high.

B is correct. Nutmeg uses the LIFO method, and thus some of the inventory on the balance sheet was purchased at a (no longer available) lower price. Zimt uses the FIFO method, so the carrying value on the balance sheet represents the most recently purchased units and thus approximates the current replacement cost.

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: $14,180. $14,980. $15,480.

B is correct. 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.

Compared to using the FIFO method to account for inventory, during periods of rising prices, a company using the LIFO method is most likely to report higher: net income. cost of sales. income taxes.

B is correct. The LIFO method increases cost of sales, thus reducing profits and the taxes thereon.

All the following statements are true regarding the LIFO reserve except:

Companies using FIFO to report their inventories are required to report the FIFO reserve to enable analysts make adjustments to their financial statements.

Which of the following expenses related to the purchase of a machine by a manufacturing company would be capitalized into the value of that machine?

Expenditures for testing costs required to make the machine usable.

Assuming all else equal and all taxes are paid in cash, in the early years of an asset's life, a firm using the double-declining balance method will report lower_____________________ compared to a firm using straight-line depreciation.

Retained Earnings

Cost of Inventories

The following are capitalized costs and included in the inventory cost on the balance sheet. They are not recognized as an expense (COGS) until the inventory is sold: •Cost of purchase: Purchase price, taxes, freight and delivery costs, insurance during transport, handling and other costs directly attributable to acquiring inventory •Costs of conversion: Direct labor costs, fixed and variable overhead costs during the production process -The following are period costs and are expensed on the income statement in the period in which they occur •Abnormal costs due to waste of materials, abnormal labor waste •Storage costs (unless required in the production process) •Administrative overhead and selling expenses

All else equal, during the first year, when X capitalizes and Y expenses you would expect to see the following:

X will have higher cash flow from operating activities

Under US GAAP, when assets are acquired in a business combination, goodwill most likely arises from:

assets that are neither tangible nor identifiable intangible assets

When constructing an asset for sale, directly related borrowing costs are most likely:

capitalized as part of inventory

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 costAcquisition datePatent expiration dateTotal plant capacity of patented productProduction of patented product in fiscal year ended 31 December 2009Expected production of patented product during life of the patent€5,800,000 1 January 2009 31 December 2015 40,000 units per year 20,000 units175,000 unitsIf the analyst uses the units-of-production method, the amortization expense on the patent for fiscal year 2009 is closest to:

€662,857.

Inventory Analysis

-Inventory Valuation Method Changes: Analyst should carefully review and understand reasons for the change •Retrospective application - except for US GAAP firms switching to LIFO •US GAAP requires firms to thoroughly explain why the new method is superiorComputing Ratios: •Profitability ratios: e.g., gross margin, net margin •Liquidity Ratios (Current Ratio): FIFO is a better measure of current inventory value on the balance sheet (economic value) •Activity Ratios: Inventory Turnover Ratio = COGS/Average Inventory, and Days of Inventory on Hand

Long-Lived Assets

-Long-term Assets/Noncurrent assets: Expected to provide economic benefits over a future period of time, typically greater than one year •Tangible: PP&E •Intangible: Patents, Trademarks -The cost (acquisition cost) of most long-lived assets is capitalized and then allocated as expenses over time as they provide economic benefits. -The following costs are included as part of the cost of an asset and are capitalized (see example 1 on p. 341) •Purchase Price •Sales Tax •Freight and insurance to get the asset to the business premises •Installation and testing costs to make the asset usable •Expenditures that extend the original life of an asset are typically capitalized

Assessing Financial Reporting Quality

-Motivations to issue financial reports that are not high quality •Mask poor performance, meet or beat market expectations (analyst forecasts) •Increase compensation that is linked to reported earnings, career concerns •Avoid violation of debt covenants -Conditions conducive to issuing low quality financial reports •Poor internal controls, ineffective corporate governance •Accounting standards that provide scope for divergent choices, or minimal consequences for an inappropriate choice -Disciplinary mechanisms for financial reporting quality include auditors, regulatory authorities, private contracting e.g. loan arrangements

Nutmeg, Inc. uses the LIFO method to account for inventory. During years in which inventory unit costs are generally rising and in which the company purchases more inventory than it sells to customers, its reported gross profit margin will most likely be: lower than it would be if the company used the FIFO method. higher than it would be if the company used the FIFO method. about the same as it would be if the company used the FIFO method.

A is correct. LIFO will result in lower inventory and higher cost of sales in periods of rising costs compared to FIFO. Consequently, LIFO results in a lower gross profit margin than FIFO.

Eric's Used Book Store prepares its financial statements in accordance with IFRS. Inventory was purchased for £1 million and later marked down to £550,000. One of the books, however, was later discovered to be a rare collectible item, and the inventory is now worth an estimated £3 million. The inventory is most likely reported on the balance sheet at: £550,000. £1,000,000. £3,000,000.

B is correct. Under IFRS, the reversal of write-downs is required if net realisable value increases. The inventory will be reported on the balance sheet at £1,000,000. The inventory is reported at the lower of cost or net realisable value. Under US GAAP, inventory is carried at the lower of cost or market value. After a write-down, a new cost basis is determined and additional revisions may only reduce the value further. The reversal of write-downs is not permitted.

Zimt AG wrote down the value of its inventory in 2007 and reversed the write-down in 2008. Compared to the ratios that would have been calculated if the write-down had never occurred, Zimt's reported 2007:current ratio was too high.gross margin was too high.inventory turnover was too high.

C is correct. The write-down reduced the value of inventory and increased cost of sales in 2007. The higher numerator and lower denominator mean that the inventory turnover ratio as reported was too high. Gross margin and the current ratio were both too low.

Butler Company reported ending inventory at 31 December 2017 of $1,200,000 under LIFO. It also reported a LIFO reserve of $210,000 on 1 January 2017, and $300,000 at 31 December 2017. The cost of goods sold (COGS) for 2017 was $4,900,000. Calculate the company's inventory at 31 December 2017 if it had used FIFO.

$1,500,000 (Ending Inventory + ending LIFO reserve); Ending LIFO Reserve = (LIFO COGS − FIFO COGS) + Beginning LIFO Reserve = ($3,988 − $2,004) + $2,484 = $4,468

If Butler Company had used FIFO during 2017, its cost of goods sold for 2017 would have been:

$4,810,000

Deferred Tax Liabilities

-A firm recognizes a DTL when a deficit amount is paid for income taxes and the company expects to eliminate the deficit over the course of future operations •Increase in taxes payable in future years as a result of taxable temporary differences existing at the end of the current year •The difference is expected to reverse therefore future taxable income (IRS) is expected to exceed pretax income (financial statements) •Temporary timing differences expected to generate net taxable amount in future years, future cash outflow •Think "I have to pay the IRS later" •E.g., a firm using straight-line depreciation for financial reporting and accelerated depreciation for tax reporting

Non-Current Liabilities

-A non-current liability broadly represents a probable sacrifice of economic benefits in periods generally greater than one year in the future -Understanding a company's solvency or the ability to pay its liabilities is important in determining if the firm will be a going-concern -Company's issue debt via mortgages, loans, notes and bonds to finance growth as an alternative to issuing equity •Long-term debt often arises from public issuance of debt securities •These are interest bearing in nature •Important role in portfolios of insurance companies, pension plans, institutional investors

Income taxes continued

-Accounting Profit and Taxable Income •A company's accounting profit/income before taxes/EBT is reported on its income statement in accordance with accounting standards •A company's taxable income is the portion of its income that is subject to income taxes under the tax laws of its jurisdiction -Differences between accounting profit and taxable income may occur because •Revenues/Expenses may be recognized in different periods for accounting and for tax purposes (Timing differences) •Some revenues/expenses may only be recognized for either accounting or for tax purposes, but not both •Carrying amount and tax base of assets/liabilities may differ •Deductibility of gains and losses may differ •Tax loss carry forwards may be used to reduce taxable income in later years -two types of statements: accounting purposes, tax purposes

Accounting and reporting after bond issuance

-Accounting and reporting after bond issuance: •Balance Sheet: Liability carried at amortized cost (historical cost plus/minus cumulative amortization) •Income Statement: Interest Expense = Bond Carrying Value x market rate of interest at the time the bonds were issued (YTM at the time of issuance) •Cash Flow Statement: Coupon payments (coupon rate x par value) reported as cash flow from operating activities. Amortization of bond discount or premium is a non-cash charge.

Inventory Write-Downs continued

-Analysts should carefully review the possibility of a write-down •May be higher in industries where technological obsolescence is a significant risk •Companies using LIFO are less likely to incur inventory write-downs because inventory carrying amount is conservatively presented at oldest and lowest cost -Reversal of write-downs: If there is a subsequent increase in value of inventory previously written down •IFRS: Required to reverse the value of inventory previously written down, limited to the amount of the original write-down - reversal recognized as a reduction in COGS •US GAAP: Reversal of inventory write-downs is prohibited

Derecognition

-Asset is derecognized when the asset is disposed of or is expected to provide no future benefits from either use or disposal -Sale Proceeds: X <— Sales proceeds reported as Cash from Investing Activities -Less: Carrying Value (X) <— Cost and accumulated depreciation removed from B/S -Gain/(Loss) X or (X) <— Accounting Gain or Loss recognized in I/S -Long-lived assets disposed of other than by a sale (e.g., abandoned, exchanged) are classified as held for use until disposal •Continue to be depreciated, tested for impairment

Capitalizing vs Expensing (continued)

-Balance Sheet effect (See example 4, p. 349): •Capitalizing firms have greater assets because capitalized assets are on the B/S •Capitalizing firms have higher equity (lower expenses leads to higher net income, hence higher Retained Earnings) •Capitalizing firms have lower debt-to-equity and debt-to-assets ratios (because of higher equity and higher assets) -Cash Flow Statement effect (See example 4, p. 349) •Capitalizing firms have lower cash flow from investing activities (Cash expenditures for capitalized assets flow through investing activities) •Capitalizing firms have higher cash flow from operations •Note that if you ignore any income tax effects, the net cash flow is the same for both

Bonds Payable

-Bond Terminology •Par/Face Value: The lump sum/principal to be repaid at maturity of the bond •Coupon Rate: Nominal/Stated rate stipulated in the contract and used to calculate the periodic interest payments. Fixed over the life of the bond. •Coupons: Periodic interest payments, usually semi-annually. Calculated as coupon rate x par value. Fixed over the life of the bond. These are payments reported on the statement of cash flows •Initial Liability: Net cash received by the company at issuance •Effective/Market Interest rate: Discount rate that makes the initial liability equal to the future repayments of coupons and par value at the time of issuance. This is the yield to maturity at the time of issuance

Bonds Payable continued

-Bonds payable equals the present value of the remaining future stream of interest and principal payments •Book value of the debt reported on the Balance Sheet uses the discount rate (market interest rate) that was in effect when the debt was issued •Contrast with market value of debt that uses current market rate of interest -At the time of issuance, firm establishes a liability, bonds payable, on its balance sheet, and increases cash. The cash is a financing cash inflow •If coupon rate = market rate, then bonds issued at par (carrying amount = par value) •If coupon rate > market rate, then bonds issued at premium •If coupon rate < market rate, then bonds issued at a discount

Revaluation Model

-Carrying amounts are the fair values of the assets. The fair value must be measured reliably •Only allowed by IFRS •Company must apply the same model to all assets within a particular class of assets •Unlike historical cost model, revaluation model may result in increases in value of long-lived assets

Depreciation and Amortization

-Cost Model: Allocate capitalized cost of a long-lived asset over its useful life •Required under GAAP, permitted under IFRS •IFRS requires component method of depreciation •Land is not depreciated -Depreciation Methods: We've encountered some of these before •Straight-line method •Accelerated (Double-declining balance) •Units-of-production method

Deferred Tax Assets

-DTA arise when an excess amount is paid for income taxes and the company expects to recover the difference during the course of future operations •Taxes have been paid but not yet been recognized on the income statement •Think "The firm has a coupon from the IRS" -Deferred Tax Assets are recognized when deductible temporary timing differences generate an operating loss or tax credit carryforward •It must be probable that the firm will generate sufficient taxable income in subsequent years to receive the tax deductions (to use the coupon) •Management and its auditors must defend the recognition of DTAs. •If the firm does not have future taxable income, they cannot realize the DTA benefit. Think "it is unlikely that the firm can use the coupon from the IRS"

Convertible Bonds

-Debt with equity like features •Debt holder has the option to exchange the debt for equity •When a bond is issued the entire proceeds of the bond are recorded as liability, the convertible feature is ignored •For analytical purposes, the analyst might want to treat the bond as equity if it is highly likely it will be converted, or leave it as debt if it is unlikely to be converted •If the stock price is close to the conversion price, then calculate ratios both ways, treating the bonds as debt and treating them as equity

Effective Tax Rates

-Firms are required to disclose a reconciliation between the company's effective income tax rate and the applicable statutory rate -Effective Tax Rate= Income Tax Expense / Pretax Income -Contrast this with statutory tax rate which is the tax rate on corporate income specified in the tax code in the jurisdiction where the firm operates -Permanent Tax differences result in a difference between the company's tax rate and statutory rate

Analyst Implications: Software Costs

-For a firm that capitalizes software development costs an analyst can make adjustments to expense all costs •Income Statement: Include software development costs as an expense and remove the amortization of the asset from depreciation/amortization expense •Balance Sheet: Remove capitalized asset and reduce retained earnings •Cash Flow: Decrease Cash Flow from Operations for the expensing costs and increase Cash Flow from Investing by the current period development costs

Par Bonds

-For par bonds, there is no premium or discount to amortize over time -For bonds not issued at par, the premium or discount is amortized over the life of the bond. When the bonds mature, the carrying amount will equal the face value -The effective interest rate method is required under IFRS and preferred under US GAAP •It better reflects the economic substance of the transaction •Alternative under US GAAP is straight-line amortization which evenly amortizes the premium of discount over the life of the bonds. It is permitted if the difference with the effective interest method is not material

Quality Spectrum of Financial Reports

-GAAP, decision-useful, sustainable, and adequate returns •High quality financial reports; -High quality earnings indicate an adequate level of return on investment, and derive from activities that are sustainable -GAAP, decision-useful, but sustainable? •High quality financial reports provide useful information; -However, the information reflects results or earnings that are not sustainable (low earnings quality) because of non-recurring items or insufficient return on investment

Impairment continued

-IFRS: An asset is considered impaired when its carrying amount exceeds its recoverable amount. -Use it: PV of future cash flows -Sell it: (Fair Value - Selling Costs) -Bigger amount of use it and sell it values is recoverable amount •Recoverable amount is the higher of fair value less selling costs or value in use (present value of expected future cash flows) -US GAAP: An asset is considered impaired when its carrying amount exceeds fair value and carrying amount is not recoverable. Two-step process for recognizing impairment: 1.Recoverability Test: Asset is impaired if the Balance Sheet carrying value (net book value) is greater than the future undiscounted cash flow from the assets' use and disposal; Yes or No -If yes... 2.Loss Measurement: If impaired, asset's value is written down to fair value. The loss is the asset's carrying value minus the fair value.

Capitalization of Interest Costs

-If a company constructs an asset or needs a long time to get an acquired asset ready for intended use, borrowing costs related to the construction are generally capitalized (See Example 2, p. 343 & Example 6, p.353) •If a firm takes out a loan to finance the construction of a building, interest on the loan during the construction would be capitalized as part of the building PP&E •If no specific borrowing is identifiable, a weighted average based on existing borrowings is used. •IFRS: Interest earned from temporarily investing borrowed funds decreases borrowing costs eligible for capitalization -The capitalized interest will be expensed over time as part of subsequent years depreciation expense -The capitalized interest payments prior to completion of construction are classified as an investing cash outflow

Inventory Write-Downs

-If the value of inventory declines below its balance sheet carrying amount, the inventory must be written down (usually through an inventory valuation allowance account (contra-asset)) •The write-down (loss) recognized as an expense on the income statement in the period incurred Inventory write-downs impacts ratios •Reduces profits, reduces carrying amount of inventory on balance sheet •Negative effect on profitability, liquidity and solvency ratios •Inventory turnover ratio and total asset turnover will be positively affected by a write-down (smaller denominator)

Impairment

-Impairment charges reflect an unanticipated decline in the value of an asset (contrast with depreciation) •Both IFRS and US GAAP require companies to write down the carrying amount of impaired assets •Impairment loss reported pre-tax as component of income from continuing operations on income statement Impairment of PP&E and Intangibles with a finite useful life •Standards don't require annual test for impairment •Company assesses at the end of each reporting period whether a significant event suggests the need to test for impairment •Examples of events: Evidence of obsolescence, technological advancements, decline in demand, changes in legal or economic factors

Impairment (continued)

-Impairment of Intangibles with indefinite lives (Think goodwill for publicly traded companies) •These are not amortized, tested at least annually for impairmentImpairment of long-lived assets held for sale •Long-lived asset that ceases to be used and management intends to sell it •Reclassified from PP&E to assets held for sale, tested for impairment at the time of reclassification, and asset ceases to be depreciated or amortized Reversals of Impairments of Long-Lived Assets •IFRS permit impairment losses to be reversed if the recoverable amount of an asset increases regardless of whether the asset is held for use or held for sale, reversal limited to the original impairment loss •US GAAP reversal permitted for assets held for sale, not for assets held for use

Impairment: Analyst Implications

-Impairments have significant effects on financial statements and ratios •Carrying Value of PP&E: Decline in value of fixed assets, fixed asset turnover and total asset turnover ratios increase •Deferred Tax Liabilities (DTL): Impairment charges are not recognized for tax purposes until asset is disposed. •Stockholder's Equity: Reduction in net income due to impairment expense, reduces book value of equity, thus increasing leverage (debt-to-equity ratio), -Price-to-Book ratio increases They also impact future financial statements •Depreciation charges will be lower in the future, therefore, net income will be higher •Lower asset values due to asset write down, lower equity due to impairment charge, therefore, ROA and ROE ratios will be higher

Amortization of Intangibles

-Intangibles with finite useful lives •Amortize over the estimated useful life •Pattern should match consumption of benefits •Example: Patents with specific expiration dates Intangibles with infinite useful lives •No amortization •Review at least annually for impairment •Example: Goodwill

Premium Bonds

-Market Rate < Coupon Rate •Proceeds received are greater than the face value, Cash Flow from Financing activities at issuance increases by the proceeds •At issuance, establish a liability (bonds payable) equal to the price of the bond •Premium is amortized over the life of the bond and will make interest expense be less than interest payments •Interest Expense = Market Rate x Carrying Value. (Interest Expense decreases over the life of the bond) •Bond carrying value decreases over the life of the bond -Each period, subtract amortization of premium from net income when preparing an indirect statement of cash flows (because interest expense is less than the actual interest payment cash flow)

Discount Bonds

-Market Rate > Coupon Rate •Proceeds received are less than the face value, Cash Flow from Financing Activities at issuance equal proceeds from bond •At issuance, establish a liability (bonds payable) equal to the price of the bond •Discount is amortized over the life of the bond and will make interest expense exceed interest payments •Interest Expense = Market Rate x Carrying Value. (Interest Expense increases over the life of the bond) •Bond carrying value increases over life of the bond -Each period, add amortization of discount to net income when preparing an indirect statement of cash flows (because interest expense is greater than the actual interest payment cash flow)

Assessing Financial Reporting Quality continued

-Motivations to issue financial reports that are not high quality •Mask poor performance, meet or beat market expectations (analyst forecasts) •Increase compensation that is linked to reported earnings, career concerns •Avoid violation of debt covenants -Conditions conducive to issuing low quality financial reports •Poor internal controls, ineffective corporate governance •Accounting standards that provide scope for divergent choices, or minimal consequences for an inappropriate choice -Disciplinary mechanisms for financial reporting quality include auditors, regulatory authorities, private contracting e.g. loan arrangements

Intangible Assets

-Non-monetary assets lacking physical substance •Copyrights, Patents, Trademarks •Definition criteria and recognition criteria section 2.2 on p. 343 -When purchased in situations that are not business combinations •Purchase price (fair value) recorded as an asset on the Balance Sheet •Analyst should understand what assets the firm has acquired and any insights they offer into company's strategic direction and future potential -When acquired through a business combination, account for it using the acquisition method of accounting •Allocate the purchase price to each asset acquired and liability assumed based on the fair value •Excess of purchase price over net assets is recorded as goodwill

Debt Extinguishment

-Once bonds are issued, they can remain outstanding until they mature, or they can be called early before redemption if they have a call provision, or purchased in the market •On the Balance Sheet reduce bonds payable or net book value •Repayment appears as a cash outflow in the financing section of the Statement of Cash Flows •Gains and losses between carrying value and cash paid in market to retire bonds go to the income statement •Note that there are no gains or losses at maturity - discount or premium is fully amortized and the carrying amount equals face value

perpetual vs. periodic inventory system

-Periodic: What we did in Chapter 3 •Inventory values and cost of sales are determined at the end of an accounting period -Perpetual: Inventory values and costs are continuously updated to reflect purchases and sales -Periodic or Perpetual: •No difference for Specific Identification and for FIFO •Differences for Weighted Average Cost and LIFO

Permanent and Temporary differences

-Permanent Differences: Differences between tax and financial reporting of revenue or expenses that will not be reversed at some future date •Result from items that enter into pretax financial income but never into taxable income or items that enter into taxable income but never pretax income •Because they will not be reversed at a future date, they do not give rise to deferred taxes -Temporary Differences: Timing differences that will eventually reverse. •Temporary differences give rise to deferred taxes •Deferred Taxes arise when the same tax in total passes through the tax returns and the financial statements but occurs in different time periods

Detection of Financial Reporting Quality Issues

-Presentation Choices •Non-GAAP measures or non-IFRS measures •Emphasize or prominently display the positive aspects of performance •Excessive or irrelevant detail that can obscure relevant information -Accounting Choices and Estimates •Revenue recognition policies and timing of revenue recognition •Inventory cost flow assumption, capitalizing versus expensing, depreciation methods and estimates •Allowance estimates (doubtful accounts, inventory obsolescence, warranty etc.)

Investment Property

-Property owned for the purposes of earning rent or capital appreciation or both •Example: Office building owned and leased out to tenants •Do not include long-lived tangible assets held for sale in the ordinary course of business e.g., houses/property owned by a construction company •Valued using either cost or fair value model •For the fair value model, all changes in fair value affect net income •There is no specific definition of investment property under US GAAP

LIFO Liquidation continued

-Reasons that can lead to LIFO liquidation •Labor strikes at a supplier, firm has to reduce inventory levels to meet demand •Declining customer demand (or during recessions), a company may choose to reduce inventory levels •Management may opportunistically choose to liquidate inventory in order to inflate the company's gross profits -Important for an analyst to review the LIFO reserve footnote disclosure to determine if LIFO liquidation has occurred •A decline in the LIFO reserve from prior period may be indicative of LIFO liquidation •Analyst should adjust COGS upwards if LIFO liquidation has occurred

Current Market Rates/Fair Value Reporting

-Reporting bonds at amortized historical costs reflects the market rate at the time the bonds were issued •As market interest rates change, the bonds' carrying value diverges from the fair market value •Decrease in market interest rates causes the fair value of fixed coupon bonds to increase, hence the economic liability a firm faces may be higher than what is reported in the books •For analysis, market value of debt is more relevant than book value because market value reflects the cost to buy back the debt and cancel the liability •IFRS and US GAAP require disclosure of the fair value of outstanding debt (unless the carrying amount approximates fair value, or the fair value cannot be reliably measured)

Debt Covenants

-Restrictions that protect creditors by restricting activities of the firm (the borrower) •Affirmative covenants: "Thou shalt" for example maintain certain ratios (solvency or interest coverage ratios) above/below a specified amount, or maintain collateral in good condition •Negative covenants: "Thou shall not" for example increase dividends, sell important assets •Research shows that covenant violations occur with some frequency. Technically it is a breach of contract •Often results in renegotiations but depending on severity, the lender may be entitled to penalty payments or may call for payment of the debt •Footnotes disclose terms

Derecognition Other Than by Sale

-Retirement or abandonment of assets •No cash proceeds •Reduce asset by the carrying amount, recognize loss equal to the carrying amount -Exchange of assets •Remove the carrying amount of the asset given up on the balance sheet •Add a fair value of the asset acquired •Any difference goes into income statement as a gain or loss •Fair value used is the fair value of the asset given up unless the fair value of the asset acquired is more clearly evident

Revaluation Model (continued)

-Revaluation below historic cost •Reduce balance sheet asset to fair value •Recognize a loss on the income statement (affects net income) •Subsequent reversals of value recognized on income statement to the extent that it reverses a revaluation decrease of the same asset class •Increase in excess of the reversal amount reported directly in equity (Other Comprehensive Income) under "revaluation surplus" •Any subsequent decrease in value first decreases this surplus -Revaluation above historic cost •Increase balance sheet asset to fair value •Gain taken directly to equity through Other Comprehensive Income •Subsequent decreases in asset's value first reduces the revaluation surplus

Valuation Analysis

-The Valuation Allowance is a contra account against Deferred Tax Assets (DTA) based on the likelihood that these assets will not be realized in the future •The realization of tax loss carryforwards depends on future taxable income. If the firm does not have future taxable income, they cannot realize the DTA •Increase in the valuation allowance reduces the net recoverable DTA and indicates that it is unlikely the firm will realize the benefits of the DTA •Increase in the valuation allowance increases income tax expense in the current period because the firm does not expect to realize a favorable tax benefit for a portion of the deductible temporary difference •Deferred Tax Assets have Valuation Allowances, but Deferred Tax Liabilities do not -For IFRS, if there is any doubt that the DTA will be recovered, reduce the carrying amount to the expected recoverable amount

Analytical Implications: DTA

-The key analytical issue is whether the DTA will actually reverse in the future -Given management's discretion, the valuation allowance has become another factor used to evaluate the quality of earnings •Conservative approach is to offset most or all of DTA with a valuation allowance •Least conservative is to recognize all of the DTA

Analytical Implications: DTL

-The key analytical issue is whether the DTL will actually reverse in the future. Are DTL liabilities or equity? How should they be handled when evaluating solvency •Changes in a firm's operations (purchasing equipment) or tax laws may result in these deferred taxes never being paid •Even if these deferred taxes are eventually paid, the present value of those payments should reduce the balance sheet liability stated amounts -Examine which components of DTL have a high likelihood of reversing •Reversing DTL: Considered a liability, the DTL should be discounted at an appropriate discount rate •Non-Reversing DTL: Reclassify as shareholder's equity. If the liability had not been recorded, prior period tax expense would have been lower, both net income and equity would have been higher

Interest Payments in Cash Flow Statements

-Under IFRS, interest payments on bonds can be included as an outflow in either the operating section or the financing section of the SCF -US GAAP requires interest payments on bonds to be included as an operating cash flow

Changes in Tax Laws and Accounting Methods

-When a new tax law is enacted, the effects must be recognized immediately •IFRS allows use of tax rates and laws that have been enacted or substantively enacted, while GAAP only uses tax rates and laws that have been enacted -DTAs and DTLs are revalued using the new tax rate that is expected to be in place when the liability reverses -Increases in tax rates or tax cuts will affect DTLs and DTAs and the adjustment is included in the current period's income tax expense •For analytical purposes, an analyst can adjust future DTL estimates while legislation is pending

LIFO Liquidation

-When inventory units manufactured or purchased exceeds the units sold, the LIFO reserve may increase from addition of new LIFO layers However, when units sold exceeds the units purchased or manufactured, the number of units in ending inventory is lower than the number of units in beginning inventory •Means that the firm is selling some old, old units therefore LIFO costs no longer approximates current replacement costs -LIFO liquidation refers to a declining inventory balance for a company using LIFO •Input prices are no longer assigned recent prices (LIFO COGS is no longer economically meaningful); COGS is calculated using "stale" prices and is therefore low •Gross profits are therefore artificially high, these profits are not sustainable

Quality Spectrum of Financial Reports (continued)

-Within GAAP but "earnings management": Making intentional choices that create biased financial reports •Real actions e.g. deferring R&D expenses into the next reporting period •Accounting choices e.g. changing accounting estimates of product returns, bad debt expense, or decreasing asset impairment -Departures from GAAP: Low quality financial reporting •Earnings quality is difficult or impossible to assess because comparisons with earlier periods or other entities cannot be made •Examples of improper accounting such as Enron, WorldCom •Fictitious accounts

Quality Spectrum of Financial Reports continued

-Within GAAP but biased choices: Assumptions and estimates that affect amount of revenue, earnings, operating cash flow etc. •Aggressive choices increase a company's reported performance and financial position in the current period •Conservative choices do the opposite in the current period - but may increase reported performance in later periods •Earnings smoothing - understating of earnings volatility •Biased choices can also be made in the context of how information is reported e.g. obscure unfavorable information and/or emphasize favorable information •Emphasizing non-GAAP financial measures to deflect attention from undesirable financial results

Deferred tax assets

-appear on the B/S -arise when an excess amount is paid for income taxes and the company expects to recover the difference during the course of future operations

3 ways of acquiring a patent (intangible assets)

-buy it outright -buy the business through a business combination -invest in R&D

Reasons for differences between accounting profit and taxable income can occur:

-revenues and expenses may be recognized in one period for accounting purposes and a different period for tax purposes -specific revenues and expenses may be either recognized for accounting purposes and not for tax purposes; or not recognized for accounting purposes but recognized for tax purposes -the carrying amount and tax base of assets and/or liabilities may differ -the deductibility of gains and losses of assets and liabilities may vary for accounting and income tax purposes -subject to tax rules, tax losses of prior years might be used to reduce taxable income in later years, resulting in differences in accounting and taxable income -adjustments of reported financial data from prior years might not be recognized equally for accounting and tax purposes or might be recognized in different period

To determine the probability of sufficient future profits for utilization, one must consider the following:

-sufficient taxable temporary differences must exist that are related to the same tax authority and the same taxable entity -the taxable temporary differences that are expected to reverse in the same periods as expected for the reversal of the deductible temporary differences

With respect to DTA's related to subsidiaries, branches, and associates and interests, DTA's will only be recognized if the following criteria are satisfied:

-the temporary difference will reverse in the future -sufficient taxable profits exist against which the temporary difference can be used

Leases

-valuing assets and obligations to be capitalized under long-term leases and measuring the amount of the lease payments and annual leasehold amortization -financial statements are supposed to behave as if they bought the car -depreciate (amortize) asset

Change in net pension asset or liability each period is viewed as having 5 components:

1. employees' service costs for the period 2. interest expense accrued on the beginning pension obligation 3. expected return on plan assets, which is a reduction in the amount of expense recognized 4. past service costs 5. actuarial gains and losses -past service costs and actuarial gains and losses are recognized as other comprehensive income

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: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?

130

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:

168,750

Companies X and Z have the same beginning-of-the-year book value of equity and the same tax rate. The companies have identical transactions throughout the year and report all transactions similarly except for one. Both companies acquire a £300,000 printer with a three-year useful life and a salvage value of £0 on 1 January of the new year. Company X capitalizes the printer and depreciates it on a straight-line basis, and Company Z expenses the printer. The following year-end information is gathered for Company X.Which of these assets is an intangible asset with a finite useful life? Company X As of 31 December: Ending shareholders' equity £10,000,000 Tax rate 25% Dividends 0.00 Net income 750,000 Based on the information given, Company Z's return on equity using year-end equity will be closest to

6.1%

When comparing a US company that uses the last in, first out (LIFO) method of inventory with companies that prepare their financial statements under international financial reporting standards (IFRS), analysts should be aware that according to IFRS, the LIFO method of inventory: is never acceptable. is always acceptable. is acceptable when applied to finished goods inventory only.

A is correct. LIFO is not permitted under IFRS.

When screening for potential equity investments based on return on equity, to control risk, an analyst would be most likely to include a criterion that requires: positive net income. negative net income. negative shareholders' equity.

A is correct. Requiring that net income be positive would eliminate companies that report a positive return on equity only because both net income and shareholders' equity are negative.

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 deferred tax asset. a deferred tax liability. no deferred tax asset or liability.

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

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 amortisation, the carrying value after one year will be closest to: €10.17 million. €10.21 million. €10.28 million.

A is correct. The coupon rate on the bonds is higher than the market rate, which indicates that the bonds will be issued at a premium. Taking the present value of each payment indicates an issue date 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 (6.0 percent) for an interest expense of €612,637. The value after one year will equal the beginning value less the amount of the premium amortised 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.

Zimt AG wrote down the value of its inventory in 2007 and reversed the write-down in 2008. Compared to the results the company would have reported if the write-down had never occurred, Zimt's reported 2008: profit was overstated cash flow from operations was overstated. year-end inventory balance was overstated.

A is correct. The reversal of the write-down shifted cost of sales from 2008 to 2007. The 2007 cost of sales was higher because of the write-down, and the 2008 cost of sales was lower because of the reversal of the write-down. As a result, the reported 2008 profits were overstated. Inventory balance in 2008 is the same because the write-down and reversal cancel each other out. Cash flow from operations is not affected by the non-cash write-down, but the higher profits in 2008 likely resulted in higher taxes and thus lower cash flow from operations.

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: rise as the maturity date approaches. decline as the maturity date approaches. remain constant throughout the life of the bond.

A is correct. The value of the liability for zero-coupon bonds increases as the discount is amortised over time. Furthermore, the amortised 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.

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: an asset under US GAAP and reduction of the carrying value of the debt under IFRS. a liability under US GAAP and reduction of the carrying value of the debt under IFRS. a cash outflow from investing activities under both US GAAP and IFRS.

A is correct. Under US GAAP, expenses incurred when issuing bonds are generally recorded as an asset and amortised 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.

sales-type leases

A type of finance lease, from a lessor perspective, where the present value of the lease payments (lease receivable) exceeds the carrying value of the leased asset. The revenues earned by the lessor are operating (the profit on the sale) and financing (interest) in nature.

A company is experiencing a period of strong financial performance. In order to increase the likelihood of exceeding analysts' earnings forecasts in the next reporting period, the company would most likely undertake accounting choices that:

Accelerate expense recognition in the current period.*

One concern when screening for stocks with low price-to-earnings ratios is that companies with low P/Es may be financially weak. What criterion might an analyst include to avoid inadvertently selecting weak companies? Net income less than zero Debt-to-total assets ratio below a certain cutoff point Current-year sales growth lower than prior-year sales growth

B is correct. A lower value of debt/total assets indicates greater financial strength. Requiring that a company's debt/total assets be below a certain cutoff point would allow the analyst to screen out highly leveraged and, therefore, potentially financially weak companies.

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

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

Cinnamon Corp. started business in 2007 and uses the weighted average cost method. During 2007, it purchased 45,000 units of inventory at €10 each and sold 40,000 units for €20 each. In 2008, it purchased another 50,000 units at €11 each and sold 45,000 units for €22 each. Its 2008 cost of sales (€ thousands) was closest to: €490. €491. €495.

B is correct. Cinnamon uses the weighted average cost method, so in 2008, 5,000 units of inventory were 2007 units at €10 each and 50,000 were 2008 purchases at €11. The weighted average cost of inventory during 2008 was thus (5,000 × 10) + (50,000 × 11) = 50,000 + 550,000 = €600,000, and the weighted average cost was approximately €10.91 = €600,000/55,000. Cost of sales was €10.91 × 45,000, which is approximately €490,950.

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

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

Like many technology companies, TechnoTools operates in an environment of declining prices. Its reported profits will tend to be highest if it accounts for inventory using the: FIFO method. LIFO method. weighted average cost method.

B is correct. In a declining price environment, the newest inventory is the lowest-cost inventory. In such circumstances, using the LIFO method (selling the newer, cheaper inventory first) will result in lower cost of sales and higher profit.

Compared to using the weighted average cost method to account for inventory, during a period in which prices are generally rising, the current ratio of a company using the FIFO method would most likely be: lower. higher. dependent upon the interaction with accounts payable.

B is correct. In a rising price environment, inventory balances will be higher for the company using the FIFO method. Accounts payable are based on amounts due to suppliers, not the amounts accrued based on inventory accounting.

Compared to a company that uses the FIFO method, during periods of rising prices a company that uses the LIFO method will most likely appear more: liquid. efficient. profitable.

B is correct. LIFO will result in lower inventory and higher cost of sales. Gross margin (a profitability ratio) will be lower, the current ratio (a liquidity ratio) will be lower, and inventory turnover (an efficiency ratio) will be higher.

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: an interest expense of £55,000 on its 2010 income statement. a liability of £982,674 on the 31 December 2010 balance sheet. a £58,736 cash outflow from operating activity on the 2010 statement of cash flows.

B is correct. The bonds will be issued at a discount because the market interest rate is higher than the stated rate. Discounting the 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 activities. Interest expense in 2010 is £58,736 (£978,938 times 6.0 percent). 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 amortisation of the initial discount (£58,736 interest expense less the £55,000 interest payment). Thus, the value of the liability at 31 December 2010 will reflect the initial value (£978,938) plus the amortised discount (£3,736), for a total of £982,674. The cash outflow of £55,000 may be presented as either an operating or financing activity under IFRS.

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

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

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? €10 million is shown as a liability, and €9 million appears as an asset. €1 million is shown as a net pension obligation. Pension assets and obligations are not required to be shown on the balance sheet but only disclosed in footnotes.

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

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 deferred tax asset. a deferred tax liability no deferred tax asset or liability.

B is correct. 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.

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

B is correct. 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.

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: deferred tax liabilities were reduced in 2007. expectations of future earning power has increased. expectations of future earning power has decreased.

B is correct. The valuation allowance is taken against 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 likelihood that future earnings will be offset by the deferred tax asset.

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

B is correct. 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.

Adjustment: LIFO to FIFO

Balance Sheet Adjustments: Converting LIFO inventory to FIFO •Add the LIFO reserve to the LIFO Inventory to convert it to FIFO Inventory •Increase retained earnings by: LIFO Reserve x (1 - Tax rate) •Increase deferred tax liability account by: LIFO Reserve x (Tax rate) Income Statement Adjustments: Converting LIFO COGS to FIFO COGS •Subtract the increase in LIFO reserve from LIFO COGS to get FIFO COGS •FIFO COGS = LIFO COGS - Increase in LIFO reserve

Inventory Valuation Methods

Balance Sheet: Carrying amount of inventories under FIFO more closely reflects current replacement values •Inventories consist of most recently purchased items •Balance Sheet presented using FIFO contains economically meaningful inventory; Inventories under LIFO are "stale" Income Statement: Cost of Sales (COGS) under LIFO more closely reflects current replacement values •COGS consists of most recently purchased items •Income Statement presented using LIFO contains economically meaningful COGS; COGS under FIFO are potentially "stale"

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

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

Galambos Corporation had an average receivables collection period of 19 days in 2003. Galambos has stated that it wants to decrease its collection period in 2004 to match the industry average of 15 days. Credit sales in 2003 were $300 million, and analysts expect credit sales to increase to $400 million in 2004. To achieve the company's goal of decreasing the collection period, the change in the average accounts receivable balance from 2003 to 2004 that must occur is closest to: -$420,000. $420,000. $836,000.

C is correct. Accounts receivable turnover is equal to 365/19 (collection period in days) = 19.2 for 2003 and needs to equal 365/15 = 24.3 in 2004 for Galambos to meet its goal. Sales/turnover equals the accounts receivable balance. For 2003, $300,000,000/19.2 = $15,625,000, and for 2004, $400,000,000/24.3 = $16,460,905. The difference of $835,905 is the increase in receivables needed for Galambos to achieve its goal.

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

C is correct. 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.

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

C is correct. 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.

Credit analysts are likely to consider which of the following in making a rating recommendation? Business risk but not financial risk Financial risk but not business risk Both business risk and financial risk

C is correct. Credit analysts consider both business risk and financial risk.

In a comprehensive financial analysis, financial statements should be: used as reported without adjustment. adjusted after completing ratio analysis. adjusted for differences in accounting standards, such as international financial reporting standards and US generally accepted accounting principles.

C is correct. Financial statements should be adjusted for differences in accounting standards (as well as accounting and operating choices). These adjustments should be made prior to common-size and ratio analysis.

Projecting profit margins into the future on the basis of past results would be most reliable when the company: is in the commodities business. operates in a single business segment. is a large, diversified company operating in mature industries.

C is correct. For a large, diversified company, margin changes in different business segments may offset each other. Furthermore, margins are most likely to be stable in mature industries.

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

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

When comparing financial statements prepared under IFRS with those prepared under US GAAP, analysts may need to make adjustments related to: realized losses. unrealized gains and losses for trading securities. unrealized gains and losses for available-for-sale securities.

C is correct. IFRS makes a distinction between unrealized gains and losses on available-for-sale debt securities that arise as a result of exchange rate movements and requires these changes in value to be recognized in the income statement, whereas US GAAP does not make this distinction.

When a database eliminates companies that cease to exist because of a merger or bankruptcy, this can result in: look-ahead bias. back-testing bias. survivorship bias.

C is correct. Survivorship bias exists when companies that merge or go bankrupt are dropped from the database and only surviving companies remain. Look-ahead bias involves using updated financial information in back-testing that would not have been available at the time the decision was made. Back-testing involves testing models in prior periods and is not, itself, a bias.

To compute tangible book value, an analyst would add goodwill to stockholders' equity. add all intangible assets to stockholders' equity. subtract all intangible assets from stockholders' equity.

C is correct. Tangible book value removes all intangible assets, including goodwill, from the balance sheet.

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

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

An analyst gathered the following data for a company ($ millions):31 Dec 2000 31 Dec 2001 Gross investment in fixed assets $2.8 $2.8 Accumulated depreciation $1.2 $1.6 The average age and average depreciable life of the company's fixed assets at the end of 2001 are closest to:Average Age Average Depreciable Life A 1.75 years 7 years B 1.75 years 14 years C 4.00 years 7 years

C is correct. The company made no additions to or deletions from the fixed asset account during the year, so depreciation expense is equal to the difference in accumulated depreciation at the beginning of the year and the end of the year, or $0.4 million. Average age is equal to accumulated depreciation/depreciation expense, or $1.6/$0.4 = 4 years. Average depreciable life is equal to ending gross investment/depreciation expense = $2.8/$0.4 = 7 years.

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: 0.58. 0.62. 0.64.

C is correct. The current debt-to-total-capital ratio is $840/($840+$520) = 0.62. To adjust for the lease commitments, an analyst should add $100 to both the numerator and denominator: $940/($940+$520) = 0.64.

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

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

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

C is correct. 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.

An analyst is evaluating the balance sheet of a US company that uses last in, first out (LIFO) accounting for inventory. The analyst collects the following data:31 Dec 05 31 Dec 06Inventory reported on balance sheet $500,000 $600,000LIFO reserve $ 50,000 $70,000Average tax rate 30% 30%After adjusting the amounts to convert to the first in, first out (FIFO) method, inventory at 31 December 2006 would be closest to: $600,000. $620,000. $670,000.

C is correct. To convert LIFO inventory to FIFO inventory, the entire LIFO reserve must be added back: $600,000 + $70,000 = $670,000.

Inventory cost is least likely to include: production-related storage costs costs incurred as a result of normal waste of materials transportation costs of shipping inventory to customers

C is correct. Transportation costs incurred to ship inventory to customers are an expense and may not be capitalized in inventory. (Transportation costs incurred to bring inventory to the business location can be capitalized in inventory.) Storage costs required as part of production, as well as costs incurred as a result of normal waste of materials, can be capitalized in inventory. (Costs incurred as a result of abnormal waste must be expensed.)

Zimt AG started business in 2007 and uses the FIFO method. During 2007, it purchased 45,000 units of inventory at €10 each and sold 40,000 units for €20 each. In 2008, it purchased another 50,000 units at €11 each and sold 45,000 units for €22 each. Its 2008 ending inventory balance (€ thousands) was closest to: €105. €109. €110.

C is correct. Zimt uses the FIFO method, and thus the first 5,000 units sold in 2008 depleted the 2007 inventory. Of the inventory purchased in 2008, 40,000 units were sold and 10,000 remain, valued at €11 each, for a total of €110,000.

Analyzed Implications: Capitalized Interest

Capitalization of interest lowers the amount of interest expense reported on the I/S, hence increases EPS in the period of capitalization. •Capitalized interest appears as an investing cash outflow•Expensed interest appears as an operating cash outflow (GAAP)•Interest Coverage ratio is overstated in the period of capitalization.Analysts can make adjustments to expense all the interest•Add capitalized interest to interest expense on the income statement•Reduce fixed assets by capitalized interest•Remove the amortization of capitalized interest from depreciation/amortization expense on the income statement•Move the cash flow to operating activities (like other interest paid by the firm)

tax base of a liability

Carrying amount of the liability minus the amount that will be deductible for tax purposes in the future.

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?

Cash flow from operating activities would increase.

How to find Ending Inventory

Cost of goods available for sale - COGS

Which of the following would most likely signal that a company may be using aggressive accrual accounting policies to shift current expenses to later periods? Over the last five-year period, the ratio of cash flow to net income has:

Decreased each year.*

Balance Sheet Item: Liability Carrying Amount > Tax Base

Deferred Tax Asset

Balance Sheet Item: Asset Carrying Amount > Tax Base

Deferred Tax Liability

Balance Sheet Item: Liability Carrying Amount < Tax Base

Deferred Tax Liability

Permanent Differences

Differences between tax and financial reporting of revenue (expenses) that will not be reversed at some future date. These result in a difference between the company's effective tax rate and statutory tax rate and do not result in a deferred tax item. -because they will not be reversed in the future, the differences do not give rise to deferred tax -these items include: income or expense items not allowed by tax legislation and tax credits for some expenditures that directly reduce taxes

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?

Double-declining balance method

When earnings are increased by deferring research and development (R&D) investments until the next reporting period, this choice is considered:

Earnings management as a result of a real action.*

If a particular accounting choice is considered aggressive in nature, then the financial performance for the current period would most likely:

Exhibit an upward bias.

Which of the following concerns would most likely motivate a manager to make conservative accounting choices?

Expected weakening in the business environment.

Financial reports of the lowest level of quality reflect:

Fictitious events.

Inventory Valuation

IFRS: Inventories measured and carried on the balance sheet at the lower of cost and Net Realizable Value (NRV) •NRV is the estimated selling price less estimated costs necessary to make the sale and estimated costs to get inventory in condition for sale -US GAAP: Inventories are measured at lower of cost and NRV except for firms using LIFO or Retail Inventory methods •For inventories measured using LIFO or Retail Inventory Methods, inventories measured at lower of cost or market value •Market value is current replacement cost subject to upper and lower limits •Upper limit: NRV, and Lower limit: NRV less a normal profit margin

A firm incurs interest costs that are directly associated with borrowings for a building it is constructing. The building will take three years to complete. Which of the following statements is not accurate?

If the firm reports under US GAAP it must expense these interest costs immediately in the income statement.

Changes in Tax Laws and Accounting Methods (continued)

If the tax rate decreases: •The decrease in DTL decreases the current tax expense •The decrease in DTA increases the current tax expense •As long as DTL > DTA (often the case) the net impact of the decrease in tax rate will be: decrease in the tax expense, increase in net income and increase in shareholder's equity -If the tax rate increases: •The increase in DTL increases the current tax expense •The increase in DTA decreases the current tax expense •As long as DTL > DTA (often the case) the net impact of the increase in tax rate will be: increase in the tax expense, decrease in net income and decrease in shareholder's equity

The information provided by a low-quality financial report will most likely:

Impede the assessment of earnings quality.

Net Realizable Value (NRV)

In the lower-of-cost-or-market approach, the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion and disposal. The NRV represents the ceiling (upper limit) under LCM. -fair value less costs to sell and complete

Adjustments: FIFO to LIFO

Income Statement: Converting FIFO COGS to LIFO COGS •Not as straightforward, information not disclosed in the footnotes •We use an approximation, estimate based on a competing firm's data •LIFO COGS = FIFO COGS + (FIFO Beg. Inv. x r) •r is the specific inflation rate in the firm's input product market, not general CPI or PPI •Estimate r using a competing firms data as:r = (∆ LIFO Reserve/FIFO Beginning Inventory)

Which of the following is most likely to reflect conservative accounting choices?

Increased debt reported on the balance sheet at the end of the current period.

Which of the following best describes an opportunity for management to issue low-quality financial reports?

Ineffective board of directors.

Inventories

Inventory is a current asset on the balance sheet, part of the firm's working capital. •Composed of: Raw materials, Work in progress and Finished goods Evaluate the mix of inventories between raw materials, work in progress and finished goods •Increase in raw materials or work-in-progress could signal expected increase in demand, increase in finished goods may signal decrease in demand and potential future write-downs Using different inventory valuation methods can result in different amounts assigned to inventory and COGS •Inventory prices are not constant over time •We'll investigate the effects of inventory choice on financial statements and ratios, and adjust data to achieve comparability between firms

A high-quality financial report may reflect:

Low earnings quality.*

A company wishing to increase earnings in the current period may choose to:

Lower estimates of uncollectible accounts receivables.*

Earnings that result from non-recurring activities most likely indicate:

Lower-quality earnings.

effective interest rate method

Method of amortizing bond discounts and premiums that bases interest computations on the carrying value of the liability. As the liability increases or decreases, the amount of interest expense also increases or decreases. -required under IFRS, preferred under US GAAP because it better reflects the economic substance of the transaction -applies the market rate in effect when the bonds were issued to the current amortized cost of the bonds to obtain interest expense for the period

With respect to Statement 3, what is the most likely effect of the impairment loss?

Net profit margins in years after 2009 will likely exceed the 2009 net profitmargin.

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?

No, because value increases resulting from revaluation can never be recognized as a profit

tax loss carry forward

Occurs when a company experiences a loss in the current period that may be used to reduce future taxable income

Which of the following situations will most likely motivate managers to inflate earnings in the current period?

Possibility of bond covenant violation.

If a company uses a non-GAAP financial measure in an SEC filing, then the company must:

Provide a reconciliation of the non-GAAP measure and equivalent GAAP measure.

Which of the following conditions best explains why a company's manager would obtain legal, accounting, and board level approval prior to issuing low-quality financial reports?

Rationalization

In contrast to earnings quality, financial reporting quality most likely pertains to:

Relevant information.

Bias in revenue recognition would least likely be suspected if:

Reported revenue is higher than the previous quarter.*

Which of the following situations represents a motivation, rather than an opportunity, to issue low-quality financial reports?

Search for a personal bonus.

Which of the following amortization methods is most likely to evenly distribute the cost of an intangible asset over its useful life?

Straight-line method

Which technique most likely increases the cash flow provided by operations?

Stretching the accounts payable credit period.*

Tax Terminology

Tax Return terminology: •Taxable Income: Income subject to tax on the IRS tax return •Taxes Payable: Tax return liability resulting from current period taxable income •Income Tax Paid: Actual amount paid for income taxes (actual cash outflow) •Tax Loss Carry Forward: Loss in the current period that can be used to reduce future taxable income •Tax Base: The amount at which an asset or liability is valued for tax purposes -Financial Reporting Terminology: •Pretax Income/Accounting Profit/Income before taxes: Income before income tax expense (or EBT) •Income Tax Expense: Expense recognized on the income statement -income tax expense = taxes payable + ΔDTL − ΔDTA •Carrying Amount/Carrying Value: Book Value of asset or liability according to accounting principles

Deductible temporary differences

Temporary differences that result in a reduction of or deduction from taxable income in a future period when the balance sheet item is recovered or settled.

taxable temporary differences

Temporary differences that result in a taxable amount in a future period when determining the taxable profit as the balance sheet item is recovered or settled. -result in a DTL when the carrying amount of an asset exceeds its tax base and, in the case of a liability, when the tax base of the liability exceeds its carrying amount

A company uses the LIFO method and a perpetual inventory system to value its inventory and has reported its year-end inventory balance on its balance sheet. Which of the following statements is most accurate?

The LIFO reserve is the difference between the reported inventory balance and the inventory value that it would have reported if it used FIFO instead.

Income tax paid

The actual amount paid for income taxes in the period -not a provision, but the actual cash outflow. -may be more or less than income tax expense -reduces income tax payable

Which of the following statements most likely describes a situation that would motivate a manager to issue low-quality financial reports?

The manager's compensation is tied to stock price performance.

Assume Topeka tests for impairment at the end of 2010 under IFRS. Based on this test, which of the following statements is most accurate?

There is an impairment loss in the amount of $25,000

Assume Topeka will continue to use the equipment and that it tests the asset for impairment at the end of 2010 under US GAAP. Based on this test, which of the following statements is most accurate?

There is no impairment

Which costs incurred with the purchase of property and equipment are expensed?

Training required to use the property and equipment

All else equal, during year 2 of operation:

Y's net profit margin ratios will be larger than X's

After reading the financial statements and footnotes of a company that follows IFRS, an analyst identified the following intangible assets: Which of these assets is an intangible asset with a finite useful life?

Yes, Product Patent No, not copyright No, not goodwill

Defined-contribution plan

a company contributes an agreed-upon (defined) amount into the plan -the agreed-upon amount is the pension expense -the amount the company contributes to the plan is treated as an operating cash outflow -accounting for such plan is straightforward because the amount of the contribution is defined and the company has no further obligation once the contribution has been made

Defined-benefit plan

a company makes promises of future benefits to be paid to the employee during retirement -i.e., a company could promise an employee annual pension payments equal to 70 percent of his final salary at retirement until death

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:Fair value Costs to sell Value in use Net carrying amount£16,800,000 £800,000 £14,500,000 £19,100,000Acquisition cost of the vehicle Acquisition date Estimated residual value at acquisition date Expected useful life Depreciation methodThe result of the sale of the vehicle is most likely

a gain of ARP 15,000

Non-current liabilities

a probable sacrifice of economic benefits in periods generally greater than one year -common types reported in a company's financial statements include long-term debt, leases, pension liabilities, and deferred tax liabilities

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:

acquisition dates

Whenever it is determined that a DTL will not be reversed,

an adjustment should be made to the liability -The DTL will be reversed, and the amount by which it is reduced should be taken directly to equity

temporary differences

arise from a difference between the carrying value and the tax base of assets and liabilities

Deferred Tax liabilities

arise when a deficit amount is paid for income taxes and the company expects to eliminate the deficit over the course of future operations

The gain or loss on a sale of a long-lived asset to which the revaluation model has been applied is most likely calculated using sales proceeds less:

carrying amount

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:

cash flow form operating activities

Jordan's response about the effect of Beta's impairment loss is most likely incor- rect with respect to the impact on its:

cash flow from operating activities

A company is most likely to:

change from the fair value model when the company transfers investment property to property, plant, and equipment.

Lease

contract between the owner of an asset (lessor) and another party seeking use of the asset (lessee) -enables the lessee to purchase the use of the leased asset

All else equal, in the fiscal year when long-lived equipment is purchased:

depreciation expense increase

A company purchases a piece of equipment for €1,500. The equipment is expected to have a useful life of five years and no residual value. In the first year of use, the units of production are expected to be 15% of the equipment's lifetime production capacity and the equipment is expected to generate €1,500 of revenue and incur €500 of cash expenses.The depreciation method yielding the lowest operating profit on the equipment in the first year of use is:

double-declining balance

Jordan's response about his approach to estimating a company's need to reinvest in its productive capacity is most likely correct regarding:

estimating the total useful life of the asset base

Should an item that gives rise to a deferred tax liability be taken directly to equity, the same should hold true for the resulting deferred tax

examples of such items: -revaluation of PP&E -long-term investments at fair value -changes in accounting policies -errors corrected against the opening balance of retained earnings -initial recognition of an equity component related to complex financial instruments -exchange rate differences arising from the currency translation procedures for foreign operations

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:

fair value

Coverage Ratios

focus on the income statement and cash flows and measure the ability of a company to cover its debt-related payments

extinguishment of debt

gain or loss is reported in I/S in a separate line item -a company typically discloses further detail about the extinguishment in the management discussion and analysis and/or notes to the financial statements

A company purchases equipment for $200,000 with a five-year useful life and salvage value of zero. It uses the double-declining balance method of depreci- ation for two years, then shifts to straight-line depreciation at the beginning of Year 3. Compared with annual depreciation expense under the double-declining balance method, the resulting annual depreciation expense in Year 4 is:

greater

Jordan's response about the financial statement impact of Alpha's decision to capitalise the cost of its new computer system is most likely correct with respect to:

higher cash flow from operating activities

With respect to Statement 4 and Exhibit 1, if AMRC had used its old classifi- cation method for its leases instead of its new classification method, the most likely effect on its 2009 ratios would be a:

higher total liabilities-to-assets ratio

Criteria for recognizing a lease as a finance lease:

indicators that the benefits and risks of owning the leased asset have been transferred to the lessee

Coupon rate, nominal rate, or stated rate

interest rate promised in the contract, which is the rate used to calculate periodic interest payments

Which of the following characteristics is most likely to differentiate investment property from property, plant, and equipment?

it earns rent

direct financing lease

lease in which the lessor finances the asset for the lessee and earns interest revenue over the lease term.

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 Year 2 Year 3 Year 4 Year 5 TotalUnits of production 2,000 2,000 2,000 2,000 2,500 10,500Compared with the units-of-production method of depreciation, if the com- pany uses the straight-line method to depreciate the equipment, its net income in Year 1 will most likely be:

lower

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:

lower

effective interest rate

market rate at the time of issuance; or borrowing rate that the company incurs on the debt -the discount rate that equates the present value of the two types of promised future cash payments to eerie selling price

Cash interest paid

not shown directly on the statement of cash flows, but companies are required to disclose interest paid separately

Lessor accounting for an operating lease under US GAAP is similar to IFRS:

over the lease term, the lessor recognizes lease receipts as income and recognizes related costs, including depreciation of the leased asset, as expenses

Defined Benefit Plan

pension plan that guarantees a specified level of retirement income -percentage of last year of salary as income every year -Present Value of Pension Obligations -Present Value of Plan Assets -When PV of assets is bigger than PV of Obligations, the plan is fully funded, there is a surplus, and Net Pension asset is recorded on the balance sheet (difference between PV's) -if the plan is underfunded (PV of obligations is bigger than PV of assets), net pension liability while be reported on balance sheet (difference between PV's)

A firm issues a bond with a 7% coupon rate. At the time of issue, the market interest rates were 6%. The bonds were most likely issued at

premium

P/CFO ratio

price to CFO per share

r is the specific inflation rate in the firm's input product market, not general CPI or PPI

r= change in LIFO reserve / FIFO Beginning Inventory

market rate of interest

rate demanded by purchasers of the bonds given the risks associated with future cash payment obligations of the particular bond issue

Under IFRS, an impairment loss on a property, plant, and equipment asset is measured as the excess of the carrying amount over the asset's:

recoverable amount

A potential advantage of leasing through a finance lease, compared with pur- chasing an asset, is most likely:

reduced risk related to asset obsolescence

Defined Contribution Plan

retirement plan in which the employer sets up an individual account for each employee and specifies the size of the investment into that account

Jordan's response about the effect of Alpha's revaluation is most likely correct with respect to the impact on its:

return on equity

Under US GAAP, a lessor classifies a lease in one of three categories:

sales-type, operating, or direct financing

Upon repayment of bonds...

the bonds payable account is reduced by the carrying amount at maturity of the bonds, and cash is reduced by an equal amount -repayment of the bonds appears in the statement of cash flows as a financing cash outflow

As the discount bond is amortized,

the carrying amount will increase to the face value -the reported interest expense will be higher than the coupon payment

As the premium bond is amortized,

the carrying value will decrease to the face value -the reported interest expense will be less than the coupon payment

When market interest rates increase,

the fair value of a bond with a fixed coupon rate decreases, and the company's economic liability may be lower than its reported debt

When market interest rates decline,

the fair value of a bond with a fixed coupon rate increases

Presentation and disclosure of long-term debt

the non-current liabilities section usually includes a single line item of the total amount of a company's long-term debt due after one year, with the portion of long-term debt due in the next 12 months shown as a current liability -notes to the financial statements provide more information on the types of a company's debt; these can be used to determine the amount and timing of future cash outflows -notes generally include stated and effective interest rates, maturity dates, restrictions imposed by creditors, and collateral pledged

The total interest expense reflects both components of the borrowing cost: (discount)

the periodic interest payments plus the amortization of the discount

taxable income

the portion of a company's income that is subject to income taxes under the tax laws of its jurisdiction

Under IFRS, what must be disclosed under the cost model of valuation for investment properties?

useful lives

An analyst is studying the impairment of the manufacturing equipment of WLP Corp., a UK-based corporation that follows IFRS. He gathers the following information about the equipment:The amount of the impairment loss on WLP Corp.'s income statement related to its manufacturing equipment is closest to:

£3,100,000.

A company acquires a patent with an expiration date in six years for ¥100 mil- lion. The company assumes that the patent will generate economic benefits that will decline over time and decides to amortize the patent using the double- declining balance method. The annual amortization expense in Year 4 is closest to:

¥9.9 million.

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 fis- cal year ended 31 December 2009. She gathers the following information about the asset:Acquisition costAcquisition dateExpected residual value at time of acquisitionJordan's response about the effect of Alpha's revaluation is most likely correct with respect to the impact on its: 1 January 2008 €500,000The 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 amorti- zation related to the customer list as of 31 December 2009 is closest to:

€1,200,000

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

€6.8 million