A414 Ch 9

Global Traders purchases a piece of equipment for $1.5 million and incurs the following expenses: • Freight charges = $250,000 • Installation charges = $25,000 • Cost of training machine maintenance staff = $12,000 • Cost of strengthening the factory floor = $5,500 • Cost of painting factory walls = $7,000 The amounts capitalized and expensed by the company are closest to:

Row II The cost of training the machine maintenance staff is not necessary to ready the asset for its intended use and is therefore expensed. Further, the cost of painting factory walls is also expensed as it does not enhance the productive capacity of the asset. Amount capitalized on the balance sheet = 1,500,000 + 250,000 + 25,000 + 5,500 = $1,780,500 Amount expensed on the income statement = 12,000 + 7,000 = $19,000

A company purchased an asset at the end of 2008. Its purchase price and the fair values at the end of 2009 and 2010 are given below: Asset Purchase Price ($) Fair value at the end of 2009 ($) Fair value at the end of 2010 ($) A 37,500 41,100 35,400 Given that the company follows the revaluation model to report the asset, answer the following question: The revaluation‐related entry on the company's income statement and revaluation surplus at the end of 2009 is closest to: Income Statement ($) Evaluation Surplus ($) I 0 41,100 II −5,700 3,600 III 0 3,600

Row III Revaluation gain in 2009 = 41,100 - 37,500 = $3,600. The increase in value will be recorded directly in shareholders' equity as revaluation surplus.

Magnus Corp is planning to expand the company's overseas operations. It starts construction of a factory in Elantica and obtains a loan of $25 million at an interest rate of 7.5%. The company's directors estimate that the factory will be completed in 5 years. During the construction period, the company invests the borrowed funds in money market instruments and earns $135,000. The amount of interest cost that would be capitalized under U.S. GAAP and IFRS is closest to: U.S. GAAP($) IFRS ($) I 937,500 924,000 I 1,875,000 1,740,000 III 9,375,000 9,240,000

Row III Interest cost capitalized under U.S. GAAP = 25m 0.075 5 = $9,375,000. Interest cost capitalized under IFRS = 9,375,000 - 135,000 = $9,240,000

Consider the following statements: • Statement 1: If inventory is subsequently classified as investment property and valued using the fair value model, the difference in value between the carrying amount and fair value at the time of transfer is recognized as profit or loss. • Statement 2: If investment property is valued using the cost model, a move to owner‐occupied property will not lead to a change in the carrying amount of the property transferred. Which of the following is most likely? Only Statement 1 is incorrect. Both statements are correct Only statement 2 is incorrect

Both statements are correct

A company purchases a machine with an expected useful life of 10 years and an estimated salvage value of $2,000 for $10,000; $4,000 of the cost of the machine represents the cost of the wheel, which is a significant component of the machine. The company estimates that the wheel will need to be replaced every 2 years. Answer the following questions assuming that the wheel has zero salvage value and that the company uses straight-line depreciation for all assets. How much depreciation would the company record for Year 1 if it uses the component method, and if it does not use the component method?

$2,400 $800 and respectively

An analyst obtains the following information about the assets of two companies, both of which follow U.S. GAAP for financial reporting purposes. Alpha Inc. owns a piece of equipment that has a carrying value of $5,200. The company estimates that the total expected future cash flows from this piece of equipment would amount to $4,200 (present value equals $3,800). The company estimates that the fair value of the asset is $5,000 and selling costs would amount to $500. Beta Inc. owns a piece of equipment that has a carrying value of $6,600. The company estimates that the total expected future cash flows from this piece of equipment would amount to $6,700 (present value equals $6,400). The company estimates that the fair value of the asset is $6,300 and selling costs would amount to $400. The amount of impairment loss recognized by Alpha Inc. is closest to:

$200 Impairment loss under U.S. GAAP = Carrying value - Fair value = 5,200 - 5,000 = $200

Katayama Inc. incurred the following expenses to purchase a piece of manufacturing equipment: Purchase price (including taxes) $15,000 Delivery charges 55 Installation charges 200 Cost of training machine maintenance staff 300 Reinforcement of factory floor to support machine 150 Cost of repairing factory roof 500 Cost of painting factory walls 325 Note: Factory roof repairs are expected to extend the life of the factory by 3 years. What is the total of these expenses that should be expensed?

$625

Three companies, Company A, Company B, and Company C, purchase an identical piece of manufacturing equipment for use in their operations. The cost of the equipment is $3,000, the estimated salvage value is $200, and the useful life of the equipment is 4 years. Further, the total production capacity of the equipment over its useful life equals 1,000 units. Each company earns $3,500 in revenues, and incurs expenses of $1,500 (excluding depreciation) every year. The companies are subject to a tax rate of 30%. Actual output levels of each of the companies over the 4 years are: Year 1 2 3 4 Production (units) 300 400 200 100 Company B uses the double declining method. Calculate it's ending net book value for year 2

$750

A company purchases an asset for $10,000. After one year, it determines that the value of the asset is $8,000 and another year later it determines that the fair value of the asset is $15,000. Assuming that the company follows the revaluation model to report this asset, which of the following is false about the financial statement impact of the revaluation in Year 1 and Year 2.

At the end of Year 2, the company will report the asset at its fair value ($8,000). The decrease in its value ($2,000) will be charged as a loss on the income statement. At the end of Year 1, the company will report the asset at its fair value ($8,000). The decrease in its value ($2,000) will be charged as a loss on the income statement. At the end of Year 2, the company will report the asset at its fair value ($15,000). The increase in value from the Year 1 value ($8,000) to the historical cost ($10,000) will essentially be reversing the previously recognized write-down (in Year 1). Therefore, a gain of $2,000 will flow through the income statement in Year 2. The remaining increase in value ($5,000) from the historical cost to the current fair value (end of Year 2) will bypass the income statement and will be recorded directly on the balance sheet under shareholders' equity in the revaluation surplus.

Which of the following statements is most likely regarding the effects of capitalization on a company's financial statements?

Capitalization reduces the company's reported total asset turnover. Capitalization of an expense results in an increase in non‐current assets, which leads to a decrease in the total asset turnover ratio (sales/assets) and the debt‐to‐assets ratio (debt/assets). Capitalization results in a decrease in CFI or an increase in outflows from investing activities.

Alpha Mining Co. purchased a machine for crushing rocks for $80,000. The machine has a useful life of 8 years and an estimated salvage value of $8,000. In order to maintain the machine, the company will need to replace one of its component parts every 3 years. This part costs $6,000 and is considered to be a significant component. The amount of depreciation expense the company should recognize in Year 1 if it does not use the component method is closest to:

Depreciation expense = (80,000 - 8,000) / 8 = $9,000

Alpha Mining Co. purchased a machine for crushing rocks for $80,000. The machine has a useful life of 8 years and an estimated salvage value of $8,000. In order to maintain the machine, the company will need to replace one of its component parts every 3 years. This part costs $6,000 and is considered to be a significant component. The amount of depreciation expense the company should recognize in Year 2 if it uses the component method of depreciation is closest to: $12,000 $10,250 $11,000

Depreciation expense = [(80,000 - 6,000 - 8,000) / 8] + (6,000 / 3) = $10,250

Alpha Mining Co. purchased a machine for crushing rocks for $80,000. The machine has a useful life of 8 years and an estimated salvage value of $8,000. In order to maintain the machine, the company will need to replace one of its component parts every 3 years. This part costs $6,000 and is considered to be a significant component. Given that the company replaced the part at the end of Year 3, the amount of depreciation expense it should recognize in Year 4 if it does not use the component method is closest to: You Answered

Depreciation expense = [(80,000 - 8,000) / 8] + (6,000 / 3) = $11,000

Which of the following statements is least likely regarding the effects of expensing on a company's financial statements?

Expensing decreases the company's cash flow from investing activities. Expensing results in an increase in NP margin in the future, as no depreciation or amortization expense is recognized in the future. Expensing has no effect on total debt and total assets, and reduces the company's cash flow from operating activities (not investing activities).

If software development costs incurred in the current period exceed amortization of prior periods' capitalized development costs, net income for the current period would most likely be: The same under both methods. Lower under expensing. Lower under capitalizing.

Lower under exp-An expensing firm would recognize the current year's development costs on the income statement, while a capitalizing firm would recognize amortization of previous periods' capitalized costs as an expense on the income statement.

Which of the following least likely describes the effects of capitalization of interest costs?

The company's reported investing cash flow is inflated. When a company capitalizes its interest costs, it does not include the capitalized amount in interest expense on its income statement, thereby inflating reported profits and reporting an enhanced ability to meet its debt servicing obligations. The related cash outflow is classified as an outflow from investing activities instead of an outflow from operating activities, so reported CFO is inflated (higher).

Which of the following statements is least accurate regarding the recognition of a gain/loss on the sale of long‐lived assets? The gain/loss on sale of a subsidiary is recognized on the income statement below income from continuing operations. Asset disposal‐related gains/losses are included in income from continuing operations. The gain/loss is reported on the income statement as part of other gains and losses if the amount is material.

The gain/loss is reported on the income statement as part of other gains and losses if the amount is insignificant. If the amount is material, the gain/loss is shown as a separate line item.

Alpha Mining Co. purchased a machine for crushing rocks for $80,000. The machine has a useful life of 8 years and an estimated salvage value of $8,000. In order to maintain the machine, the company will need to replace one of its component parts every 3 years. This part costs $6,000 and is considered to be a significant component. Given that the part is replaced every 3 years for $6,000, total depreciation expense over the 8‐year period if the company does not use the component method will most likely be:

The same as if the company uses the component method. If the company does not use the component method, total depreciation charged over the 8 years given that the part is replaced every 3 years is calculated as follows: Depreciation expense each year for the first 3 years = (80,000 - 8,000) / 8 = $9,000 Depreciation expense for the next 5 years = [(80,000 - 8,000) / 8] + (6,000 / 3) = $11,000 Therefore, total depreciation expense = (9,000 × 3) + (11,000 × 5) = $82,000 If the company does use the component method, total depreciation charged over the 8 years is calculated as: = 10,250 × 8 = $82,000

At the end of 2008, Mega Constructors purchases a piece of machinery for $1.2 million. The company uses the straight‐line method of depreciation and estimates that the machinery would have a useful life of 8 years and zero salvage value at the end of its useful life. At the end of 2010, the company estimates that the expected future cash flows from the machine will amount to $700,000 (present value equals $680,000). It further estimates that the fair value of the machine is $720,000 and selling costs would amount to $25,000. Given that the company uses U.S. GAAP for financial reporting purposes, the amount of impairment loss it will recognize on its income statement is closest to: $200,000 $220,000 $180,000

Under U.S. GAAP, an asset is considered impaired when its carrying value exceeds the total value of its undiscounted expected future cash flows. The impairment loss is then calculated as the asset's carrying value minus its fair value. Depreciation expense = 1,200,000 / 8 = $150,000 Therefore, carrying value at the end of 2010 = 1,200,000 - (150,000 × 2) = $900,000 The asset's carrying value ($900,000) is greater than its undiscounted expected future cash flows ($700,000) and is therefore impaired. Impairment loss = 900,000 - 720,000 = $180,000

Three companies, Company A, Company B, and Company C, purchase an identical piece of manufacturing equipment for use in their operations. The cost of the equipment is $3,000, the estimated salvage value is $200, and the useful life of the equipment is 4 years. Further, the total production capacity of the equipment over its useful life equals 1,000 units. Each company earns $3,500 in revenues, and incurs expenses of $1,500 (excluding depreciation) every year. The companies are subject to a tax rate of 30%. Actual output levels of each of the companies over the 4 years are: Year 1 2 3 4 Production (units) 300 400 200 100 Company C uses the units-of-production method. Calculate it's ending net book value for year 2. $750 $1,600 $1,040

1040- see study guide

Katayama Inc. incurred the following expenses to purchase a piece of manufacturing equipment: Purchase price (including taxes) $15,000 Delivery charges 55 Installation charges 200 Cost of training machine maintenance staff 300 Reinforcement of factory floor to support machine 150 Cost of repairing factory roof 500 Cost of painting factory walls 325 Note: Factory roof repairs are expected to extend the life of the factory by 3 years. What is the total of these expenses that should be capitalized? $16,230 $15,905 $15,405

15,905. See 9A for solution

Three companies, Company A, Company B, and Company C, purchase an identical piece of manufacturing equipment for use in their operations. The cost of the equipment is $3,000, the estimated salvage value is $200, and the useful life of the equipment is 4 years. Further, the total production capacity of the equipment over its useful life equals 1,000 units. Each company earns $3,500 in revenues, and incurs expenses of $1,500 (excluding depreciation) every year. The companies are subject to a tax rate of 30%. Actual output levels of each of the companies over the 4 years are: Year 1 2 3 4 Production (units) 300 400 200 100 Company A uses the straight-line method of depreciation. Calculate it's ending net book value for year 2. $1,600 $1,040 $750

1600. See study guide for solution

A company purchases a machine with an expected useful life of 10 years and an estimated salvage value of $2,000 for $10,000; $4,000 of the cost of the machine represents the cost of the wheel, which is a significant component of the machine. The company estimates that the wheel will need to be replaced every 2 years. Answer the following questions assuming that the wheel has zero salvage value and that the company uses straight-line depreciation for all assets. Assuming that a new wheel is purchased at the end of Year 2, how much depreciation would the company record (in Year 3) if it uses the component method, and if it does not use the component method? $2,400 $800 and respectively $2,000 and $4,000 respectively $2,800 and $2,400 respectively

2800 and 2400 respectively- see study guide

Consider the following information regarding ABC Company: 2011 2010 2009 EBIT 586,225 467,350 354,300 Interest expense 59,786 43,556 23,864 Interest capitalized 10,000 3,300 7,000 Net cash flow from operating activities 15,206 15,964 15,735 Net cash flow from investing activities 52,436 (176,376) (192,363) Calculate ABC's interest coverage ratio for 2011 after adjusting for capitalized interest. Assume that interest capitalized in previous periods increased depreciation expense by $620 in 2011, by $580 in 2010, and by $560 in 2009. 9.81 8.41 14.85

8.41 See 9A for solution

If management wants to report an improving return on assets over time, it would most likely use: An accelerated depreciation method. The units of production method. The straight line method.

Accelerated depreciation methods result in improving asset turnover, operating profit margins, and return on assets over time.

A company purchases an asset for $5,000. After one year, it determines that the value of the asset is $7,700 and another year later it determines that the fair value of the asset is $2,400. Assuming that the company follows the revaluation model to report this asset, which of the following is false about the financial statement impact of the revaluation in Year 1 and Year 2.

At the end of Year 2, the company will report its fair value ($7,700). The decrease in its value ($2,700) will be recorded directly on the balance sheet under shareholders' equity in the revaluation surplus. At the end of Year 1, the company will report the asset at its fair value ($7,700). The increase in its value ($2,700) will be recorded directly on the balance sheet under shareholders' equity in the revaluation surplus. At the end of Year 2, the company will report the asset at its fair value ($2,400). The decrease in value from the Year 1 value ($7,700) to the historical cost ($5,000) will essentially be reversing the previously recognized increase in value (in Year 1). Therefore, the revaluation surplus (shareholders' equity) will be reduced by $2,700. The remaining decrease in value ($2,600) from the historical cost to the current fair value (end of Year 2) will be recorded as a loss on the income statement.

An analyst obtains the following information about the assets of two companies, both of which follow U.S. GAAP for financial reporting purposes. Alpha Inc. owns a piece of equipment that has a carrying value of $5,200. The company estimates that the total expected future cash flows from this piece of equipment would amount to $4,200 (present value equals $3,800). The company estimates that the fair value of the asset is $5,000 and selling costs would amount to $500. Beta Inc. owns a piece of equipment that has a carrying value of $6,600. The company estimates that the total expected future cash flows from this piece of equipment would amount to $6,700 (present value equals $6,400). The company estimates that the fair value of the asset is $6,300 and selling costs would amount to $400. Which of the following statements is most accurate? Only Alpha Inc.'s asset has been impaired. Both the companies' assets have been impaired. Only Beta Inc.'s asset has been impaired.

Beta Inc.'s asset is not impaired because its carrying value ($6,600) is lower than the value of its undiscounted expected future cash flows ($6,700).

An analyst obtains the following information about the assets of two companies, both of which follow U.S. GAAP for financial reporting purposes. Alpha Inc. owns a piece of equipment that has a carrying value of $5,200. The company estimates that the total expected future cash flows from this piece of equipment would amount to $4,200 (present value equals $3,800). The company estimates that the fair value of the asset is $5,000 and selling costs would amount to $500. Beta Inc. owns a piece of equipment that has a carrying value of $6,600. The company estimates that the total expected future cash flows from this piece of equipment would amount to $6,700 (present value equals $6,400). The company estimates that the fair value of the asset is $6,300 and selling costs would amount to $400. The impairment loss will most likely reduce Alpha Inc.'s:

Carrying value of the equipment to $5,000. Alpha Inc's non‐current assets will decrease by $200 to $5,000 and it will recognize a loss of $200 on the income statement.

If construction and sale of buildings is a company's core business activity, interest expenses incurred in financing construction are most likely included as a part of the company's: Current assets and COGS. Current assets and non‐operating expenses. Non‐current assets and operating expenses.

Current Assets and COGS-- If construction and sale of buildings is a company's core business activity, interest expenses incurred in financing construction are included as a part of the company's inventory (current assets) and recognized as COGS in the period that buildings are sold.

Which of the following is least likely to be capitalized under U.S. GAAP?

Internally generated goodwill U.S. GAAP does not permit the recognition of internally generated goodwill. Any associated costs must be expensed when incurred.

Amortization of an intangible asset most likely: Increases owners' equity. Decreases retained earnings. Decreases cash flow from investing activities.

Decreased Retained Earnings- Amortization of an intangible asset decreases non‐current assets, net income, retained earnings, and owners' equity. Cash flow from investing activities is not affected.

Which of the following statements is least accurate? Capitalization: Decreases cash flow from investing activities in the year of recognition. Decreases cash flow from operating activities in the year of recognition. Increases non‐current assets.

Decreases cash flow from operating activities in the year of recognition. Capitalization increases non‐current assets and reduces cash flow from investing activities. Cash flow from operating activities is not affected.

A company that expenses a cost least likely reports: Higher return on equity in the first year compared to a company that capitalizes the cost. Lower net profit margin in the first year compared to a company that capitalizes the cost. Higher variability in reported net income compared to a company that capitalizes the cost.

Higher ROE- A company that expenses an item reports a lower return on equity in the year of expense recognition due to lower net income.

Which of the following statements about reversals of impairment losses is least accurate? U.S. GAAP does not allow reversals of impairment losses for assets held‐for‐use. IFRS allows reversals of impairment losses only for assets held‐for‐sale. U.S. GAAP allows reversals of impairment losses for assets held‐for‐sale.

IFRS allows reversals of impairment losses if the values of assets increase, regardless of their classification.

Which of the following types of assets are most likely amortized? Intangible assets with finite lives Goodwill Tangible assets with finite useful lives

Intangible assets with finite useful lives are amortized over their useful lives.

Two companies, Clark Inc. and Noon Inc., commence operations and issue $500 of common stock for cash. In Year 1, they each spend $450 to purchase a piece of equipment. Both companies make cash sales of $750 and incur cash operating expenses of $250 each year for 3 years. Clark estimates the useful life of the equipment to be 3 years with zero salvage value, while Noon expenses the entire cost of the equipment in Year 1. Both companies are subject to a 30% tax rate. Clark capitalizes the cost of the asset with annual depreciation equals $150 (straight-line basis). Noon expenses the entire cost of the asset in Year 1. Which company reports higher total cash flow over the 3 years?

They each report the same amount

At the end of 2008, Mega Constructors purchases a piece of machinery for $1.2 million. The company uses the straight‐line method of depreciation and estimates that the machinery would have a useful life of 8 years and zero salvage value at the end of its useful life. At the end of 2010, the company estimates that the expected future cash flows from the machine will amount to $700,000 (present value equals $680,000). It further estimates that the fair value of the machine is $720,000 and selling costs would amount to $25,000. Given that the company uses IFRS for financial reporting purposes, the amount of impairment loss it will recognize on its income statement is closest to:

Under IFRS, an asset is considered impaired when its carrying amount exceeds its recoverable amount. The recoverable amount equals the higher of "fair value less costs to sell" and "value in use," where "value in use" refers to the discounted value of future cash flows expected from the asset. The impairment loss is then calculated as the asset's carrying value minus the recoverable amount. Carrying value of the asset at the end of 2010 = $900,000 Fair value less costs to sell = 720,000 - 25,000 = $695,000 Value in use = $680,000 Therefore, recoverable amount = $695,000 Impairment loss = 900,000 - 695,000 = $205,000

A company borrows $10 million to finance the construction of an office building where it expects to base its headquarters for the next 50 years. The interest rate on the loan is 6%. Construction takes 3 years, and over this period the company earns $65,000 from investing the borrowed funds in money-market instruments. What amount of interest cost would the company capitalize under IUS GAAP? $1,735,000 $10,600,000 $1,800,000

Under U.S. GAAP, the company would capitalize the amount of interest paid on the loan during construction. This amount equals ($10m × 0.06 × 3) = $1,800,000. Under IFRS, the amount that can be capitalized must be adjusted for income earned from temporarily investing borrowed funds. Therefore, capitalized interest would equal $1,800,000 − $65,000 = $1,735,000