Financial Reporting and Analysis (3)
A lessee that enters into a finance lease will report the: lease payable on its balance sheet. full lease payment on its income statement. full lease payment as an operating cash flow.
A is correct. A finance lease is similar to borrowing money and buying an asset; a company that enters into a finance lease as the lessee reports an asset (leased asset) and related debt (lease payable) on its balance sheet. A company that enters into a finance lease as the lessee will report interest expense and depreciation expense on its income statement. A company that enters into an operating lease will report the lease payment on its income statement. For a finance lease, only the portion of the lease payment relating to interest expense reduces operating cash flow; the portion of the lease payment that reduces the lease liability appears as a cash outflow in the financing section. A company that enters into an operating lease as the lessee will report the full lease payment as an operating cash outflow.
Which of the following will cause a company to show a lower amount of amortization of intangible assets in the first year after acquisition? A higher residual value. A higher amortization rate. A shorter useful life.
A is correct. A higher residual value results in a lower total depreciable cost and, therefore, a lower amount of amortization in the first year after acquisition (and every year after that).
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.
Compared with a finance lease, an operating lease: is similar to renting an asset. is equivalent to the purchase of an asset. term is for the majority of the economic life of the asset.
A is correct. An operating lease is an agreement that allows the lessee to use an asset for a period of time. Thus, an operating lease is similar to renting an asset, whereas a finance lease is equivalent to the purchase of an asset by the lessee that is directly financed by the lessor.
A company is comparing straight-line and double-declining balance amortization 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. €118,600. €200,000.
A is correct. As shown in the following calculations, at the end of Year 4, the difference between the net book values calculated using straight-line versus double-declining balance is closest to €81,400.
Previously, a manufacturer of high-quality industrial electrical generators only sold its units to customers, but it has just introduced a leasing program. The generators have expected useful lives of about 25 years, and the company anticipates that the leases will have a term of 20 years or more. If the company reports under International Financial Reporting Standards, which of the following statements about the first year of the new leasing program is most accurate? The company will recognize: revenue equal to the value of the leased asset. depreciation of the leased asset as an expense. cost of goods sold equal to the market value of the asset.
A is correct. Because the company is a manufacturer, under IFRS the lessor would classify the lease as a finance lease and recognize revenue equal to the value of the leased asset and cost of goods sold equal to the carrying value of the asset, not its market value. The asset would be derecognized from the balance sheet and replaced with a lease receivable therefore there is no asset to depreciate.
CROCO S.p.A sells an intangible asset with a historical acquisition cost of €12 million and an accumulated depreciation of €2 million and reports a loss on the sale of €3.2 million. Which of the following amounts is most likely the sale price of the asset? €6.8 million €8.8 million €13.2 million
A is correct. Gain or loss on the sale = Sale proceeds - Carrying amount. Rearranging this equation, Sale proceeds = Carrying amount + Gain or loss on sale. Thus, Sale price = (12 million - 2 million) + (-3.2 million) = 6.8 million.
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.
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.
All else equal, in the fiscal year when long-lived equipment is purchased: depreciation expense increases. cash from operations decreases. net income is reduced by the amount of the purchase.
A is correct. In the fiscal year when long-lived equipment is purchased, the assets on the balance sheet increase and depreciation expense on the income statement increases because of the new long-lived asset.
Investment property is most likely to: earn rent. be held for resale. be used in the production of goods and services.
A is correct. Investment property earns rent. Inventory is held for resale, and property, plant, and equipment are used in the production of goods and services.
LIFO reserve is most likely to increase when inventory unit: costs are increasing. costs are decreasing. levels are decreasing.
A is correct. LIFO reserve is the FIFO inventory value less the LIFO inventory value. In periods of rising inventory unit costs, the carrying amount of inventory under FIFO will always exceed the carrying amount of inventory under LIFO. The LIFO reserve may increase over time as a result of the increasing difference between the older costs used to value inventory under LIFO and the more recent costs used to value inventory under FIFO. When inventory unit levels are decreasing, the company will experience a LIFO liquidation, reducing the LIFO reserve.
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.
Which of the following best describes a reason a company would acquire the use of equipment through an operating lease rather than by purchase? To take advantage of less costly financing To obtain preferential tax treatment for the lease payments compared with ownership To increase cash from operations
A is correct. Leases can provide less costly financing. Because of the tax and economic advantages enjoyed by lessors, they are often able and willing to offer attractive lease terms resulting in less costly financing to the lessees. B is incorrect because lessors (the owners) are normally in a better position to take advantage of tax deductions, such as depreciation and interest. C is incorrect because cash from operations would be lower with an operating lease compared to purchasing the asset.
A company issues €10,000,000 face value of 10-year bonds dated 1 January 2015 when the market interest rate on bonds of comparable risk and terms is 6%. The bonds pay 7% interest annually on 31 December. Based on the effective interest rate method, the interest expense on 31 December 2015 is closest to: €644,161. €700,000. €751,521.
A is correct. Sales proceeds of €10,736,008.71. Sales proceeds * 0.06 = interest expense
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.
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.
Costs incurred for intangible assets are generally expensed when they are: internally developed. individually acquired. acquired in a business combination.
A is correct. The costs to internally develop intangible assets are generally expensed when incurred.
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. carrying amount adjusted for impairment. historical cost net of accumulated depreciation.
A is correct. The gain or loss on the sale of long-lived assets is computed as the sales proceeds minus the carrying amount of the asset at the time of sale. This is true under the cost and revaluation models of reporting long-lived assets. In the absence of impairment losses, under the cost model, the carrying amount will equal historical cost net of accumulated depreciation.
Zimt AG wrote down the value of its inventory in 2017 and reversed the write-down in 2018. Compared to the results the company would have reported if the write-down had never occurred, Zimt's reported 2018: 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 2018 to 2017. The 2017 cost of sales was higher because of the write-down, and the 2018 cost of sales was lower because of the reversal of the write-down. As a result, the reported 2018 profits were overstated. Inventory balance in 2018 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 2018 likely resulted in higher taxes and thus lower cash flow from operations.
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. Units-of-production method. Double-declining balance method.
A is correct. The straight-line method is the method that evenly distributes the cost of an asset over its useful life because amortization is the same amount every year.
In early 2018 Sanborn Company must pay the tax authority €37,000 on the income it earned in 2017. This amount was recorded on the company's 31 December 2017 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.
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.
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.
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. net income is affected by all changes in the fair value of the asset. net income is never affected if the asset increases in value from its carrying amount.
A is correct. Under both the revaluation model for property, plant, and equipment and the fair model for investment property, the asset's fair value must be able to be measured reliably. Under the fair value model, net income is affected by all changes in the asset's fair value. Under the revaluation model, any increase in an asset's value to the extent that it reverses a previous revaluation decrease will be recognized on the income statement and increase net income.
A company is selling a long-lived asset with a carrying amount of $70,000 for $80,000. The original cost of this asset was $120,000. In the year of sale, this event is most likely to be reported on the income statement as: a gain of $10,000. a loss of $40,000. revenues of $80,000.
A is correct. When a long-lived asset is sold, only the net gain or loss is reported on the income statement. The gain or loss on a sale = Sales proceeds − Carrying amount = $80,000 − $70,000 = $10,000 gain.
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.
If inventory unit costs are increasing from period-to-period, a LIFO liquidation is most likely to result in an increase in: gross profit. LIFO reserve. inventory carrying amounts.
A is correct. When the number of units sold exceeds the number of units purchased, a company using LIFO will experience a LIFO liquidation. If inventory unit costs have been rising from period-to-period and a LIFO liquidation occurs, it will produce an increase in gross profit as a result of the lower inventory carrying amounts of the liquidated units (lower cost per unit of the liquidated units).
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.
A company using the last-in, first-out (LIFO) inventory method reports a year-end LIFO reserve of $85,000, which is $20,000 lower than the prior year. If the company had used first-in, first-out (FIFO) instead of LIFO in that year, its financial statements would most likely have reported: a higher cost of goods sold (COGS) but a lower inventory balance. both a higher cost of goods sold (COGS) and a higher inventory balance. a lower cost of goods sold (COGS) but a higher inventory balance.
B is correct.
Which of the following most likely signals that a manufacturing company expects demand for its product to increase? Finished goods inventory growth rate higher than the sales growth rate Higher unit volumes of work in progress and raw material inventories Substantially higher finished goods, with lower raw materials and work-in-process
B is correct. A significant increase (attributable to increases in unit volume rather than increases in unit cost) in raw materials and/or work-in-progress inventories may signal that the company expects an increase in demand for its products. If the growth of finished goods inventories is greater than the growth of sales, it could indicate a decrease in demand and a decrease in future earnings. A substantial increase in finished goods inventories while raw materials and work-in-progress inventories are declining may signal a decrease in demand for the company's products.
Which of the following best describes reporting and disclosure requirements for a company that enters into an operating lease as the lessee? The operating lease obligation is: reported as a receivable on the balance sheet. disclosed in notes to the financial statements. reported as a component of debt on the balance sheet.
B is correct. An operating lease is economically similar to renting an asset. A company that enters into an operating lease as a lessee reports a lease expense on its income statement during the period it uses the asset and reports no asset or liability on its balance sheet. The operating lease is disclosed in notes to the financial statements.
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.
A company acquires a patent with an expiration date in six years for ¥100 million. 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: ¥6.6 million. ¥9.9 million. ¥19.8 million.
B is correct. As shown in the following calculations, under the double-declining balance method, the annual amortization expense in Year 4 is closest to ¥9.9 million. Annual amortization expense = 2 × Straight-line amortization rate × Net book value. Amortization expense Year 4 = 33.3% × ¥29.6 million = ¥9.9 million.
Company A adheres to US GAAP and Company B adheres to IFRS. Which of the following is most likely to be disclosed on the financial statements of both companies? Any material income resulting from the liquidation of LIFO inventory The amount of inventories recognized as an expense during the period The circumstances that led to the reversal of a write down of inventories
B is correct. Both US GAAP and IFRS require disclosure of the amount of inventories recognized as an expense during the period. Only US GAAP allows the LIFO method and requires disclosure of any material amount of income resulting from the liquidation of LIFO inventory. US GAAP does not permit the reversal of prior-year inventory write downs.
Cinnamon Corp. started business in 2017 and uses the weighted average cost method. During 2017, it purchased 45,000 units of inventory at €10 each and sold 40,000 units for €20 each. In 2018, it purchased another 50,000 units at €11 each and sold 45,000 units for €22 each. Its 2018 cost of sales (€ thousands) was closest to: €490. €491. €495.
B is correct. Cinnamon uses the weighted average cost method, so in 2018, 5,000 units of inventory were 2017 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.
During periods of rising inventory unit costs, a company using the FIFO method rather than the LIFO method will report a lower: current ratio. inventory turnover. gross profit margin.
B is correct. During a period of rising inventory costs, a company using the FIFO method will allocate a lower amount to cost of goods sold and a higher amount to ending inventory as compared with the LIFO method. The inventory turnover ratio is the ratio of cost of sales to ending inventory. A company using the FIFO method will produce a lower inventory turnover ratio as compared with the LIFO method. The current ratio (current assets/current liabilities) and the gross profit margin [gross profit/sales = (sales less cost of goods sold)/sales] will be higher under the FIFO method than under the LIFO method in periods of rising inventory unit costs.
Compared with a company that uses the FIFO method, during a period of rising unit inventory costs, a company using the LIFO method will most likely appear more: liquid. efficient. profitable.
B is correct. During a period of rising inventory prices, a company using the LIFO method will have higher cost of cost of goods sold and lower inventory compared with a company using the FIFO method. The inventory turnover ratio will be higher for the company using the LIFO method, thus making it appear more efficient. Current assets and gross profit margin will be lower for the company using the LIFO method, thus making it appear less liquid and less profitable.
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: useful lives. acquisition dates. amount of disposals.
B is correct. IFRS do not require acquisition dates to be disclosed.
A company redeems $1,000,000 face value bonds with a carrying value of $990,000. If the call price is 104 the company will: reduce bonds payable by $1,000,000. recognize a loss on the extinguishment of debt of $50,000. recognize a gain on the extinguishment of debt of $10,000.
B is correct. If a company decides to redeem a bond before maturity, bonds payable is reduced by the carrying amount of the debt. The difference between the cash required to redeem the bonds and the carrying amount of the bonds is a gain or loss on the extinguishment of debt. Because the call price is 104 and the face value is $1,000,000, the redemption cost is 104% of $1,000,000 or $1,040,000. The company's loss on redemption would be $50,000 ($990,000 carrying amount of debt minus $1,040,000 cash paid to redeem the callable bonds).
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.
In a period of declining inventory unit costs and constant or increasing inventory quantities, which inventory method is most likely to result in a higher debt-to-equity ratio? LIFO FIFO Weighted average cost
B is correct. In an environment of declining inventory unit costs and constant or increasing inventory quantities, FIFO (in comparison with weighted average cost or LIFO) will have higher cost of goods sold (and net income) and lower inventory. Because both inventory and net income are lower, total equity is lower, resulting in a higher debt-to-equity ratio.
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? Yes. No, because this revaluation is recorded directly in equity. No, because value increases resulting from revaluation can never be recognized as a profit.
B is correct. In this case, the value increase brought about by the revaluation should be recorded directly in equity. The reason is that under IFRS, an increase in value brought about by a revaluation can only be recognized as a profit to the extent that it reverses a revaluation decrease of the same asset previously recognized in the income statement
The most appropriate treatment for intangible assets with indefinite useful lives is to: expense. capitalize with no amortization. capitalize and amortize.
B is correct. Intangible assets assumed to have indefinite useful lives (i.e., no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the company) are capitalized and not amortized.
Mustard Seed PLC adheres to IFRS. It recently purchased inventory for €100 million and spent €5 million for storage prior to selling the goods. The amount it charged to inventory expense (€ millions) was closest to: €95. €100. €105.
B is correct. Inventory expense includes costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition. It does not include storage costs not required as part of production.
Which of the following characteristics is most likely to differentiate investment property from property, plant, and equipment? It is tangible. It earns rent. It is long-lived.
B is correct. Investment property earns rent. Investment property and property, plant, and equipment are tangible and long-lived.
Because of a problem with the production process, a manufacturer produced a batch of defective finished goods with a total cost of $18,000. The sales value of this batch in its current condition is $6,000. With $3,000 of additional processing, however, the batch could be sold for $11,000. The value of the unsold inventory, on the balance sheet of a company using International Financial Reporting Standards (IFRS), is closest to: $9,000. $8,000. $11,000.
B is correct. Under IFRS, inventory is carried at the lower of cost and net realizable value (NRV). The company would logically choose to sell the batch at its highest realizable value.
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.
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.
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.
For a bond issued at a premium, using the effective interest rate method, the: carrying amount increases each year. amortization of the premium increases each year. premium is evenly amortized over the life of the bond.
B is correct. The amortization of the premium equals the interest payment minus the interest expense. The interest payment is constant and the interest expense decreases as the carrying amount decreases. As a result, the amortization of the premium increases each year.
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.
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.
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.
A firm issues a bond with a coupon rate of 5.00% when the market interest rate is 5.50% on bonds of comparable risk and terms. One year later, the market interest rate increases to 6.00%. Based on this information, the effective interest rate is: 5.00%. 5.50%. 6.00%.
B is correct. The market interest rate at the time of issuance is the effective interest rate that the company incurs on the debt. The effective interest rate is the discount rate that equates the present value of the coupon payments and face value to their selling price. Consequently, the effective interest rate is 5.50%.
Zimt AG presents its financial statements in accordance with US GAAP. In Year 3, Zimt discloses a valuation allowance of $1,101 against total deferred tax assets of $19,201. In Year 2, 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 Year 3. 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.
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: fair value. recoverable amount. undiscounted expected future cash flows.
B is correct. Under IFRS, an impairment loss is measured as the excess of the carrying amount over the asset's recoverable amount. The recoverable amount is the higher of the asset's fair value less costs to sell and its value in use. Value in use is a discounted measure of expected future cash flows. Under US GAAP, assessing recoverability is separate from measuring the impairment loss. If the asset's carrying amount exceeds its undiscounted expected future cash flows, the asset's carrying amount is considered unrecoverable and the impairment loss is measured as the excess of the carrying amount over the asset's fair value.
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.
A company that reports under US GAAP leases assets for its own use and classifies its leases as finance leases. In the first year of a least, how would it most likely report a lease payment on its Statement of Cash Flows? The full payment in cash from operations The interest portion of the payment in cash from operations The full payment in cash from financing activities
B is correct. Under US GAAP, when a lease is classified as a finance lease, the lease payment is split between an interest portion, which is reported in cash from operations, and a principal repayment portion reported in financing activities.
All else being equal, which of the following depreciation methods is most likely to result in higher operating margins in the later years of an asset's useful life? Straight line Declining balance Units of production
B is correct. Under the declining balance approach, depreciation is calculated as a fixed percentage of the asset's carrying amount, year after year. As the undepreciated value decreases, so does the reported depreciation expense. The effect is most pronounced in the later years of the asset's life when the undepreciated cost is much lower and hence the expense is lower (and operating margins higher).
Comte Industries issues $3,000,000 worth of three-year bonds dated 1 January 2015. The bonds pay interest of 5.5% annually on 31 December. The market interest rate on bonds of comparable risk and term is 5%. The sales proceeds of the bonds are $3,040,849. Under the straight-line method, the interest expense in the first year is closest to: $150,000. $151,384. $152,042.
B is correct. Under the straight-line method, the bond premium is amortized equally over the life of the bond. The annual interest payment is $165,000 ($3,000,000 × 5.5%) and annual amortization of the premium under the straight-line method is $13,616 [($3,040,849 - $3,000,000)/3)]. The interest expense is the interest payment less the amortization of the premium ($165,000 - $13,616 = $151,384).
When constructing an asset for sale, directly related borrowing costs are most likely: expensed as incurred. capitalized as part of inventory. capitalized as part of property, plant, and equipment.
B is correct. When a company constructs an asset, borrowing costs incurred directly related to the construction are generally capitalized. If the asset is constructed for sale, the borrowing costs are classified as inventory.
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.
A company is most likely to: use a fair value model for some investment property and a cost model for other investment property. change from the fair value model when transactions on comparable properties become less frequent. change from the fair value model when the company transfers investment property to property, plant, and equipment.
C is correct. A company will change from the fair value model to either the cost model or revaluation model when the company transfers investment property to property, plant, and equipment.
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.
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.
A write down of the value of inventory to its net realizable value will have a positive effect on the: balance sheet. income statement. inventory turnover ratio.
C is correct. Activity ratios (for example, inventory turnover and total asset turnover) will be positively affected by a write down to net realizable value because the asset base (denominator) is reduced. On the balance sheet, the inventory carrying amount is written down to its net realizable value and the loss in value (expense) is generally reflected on the income statement in cost of goods sold, thus reducing gross profit, operating profit, and net income.
Which of the following is an example of an affirmative debt covenant? The borrower is: prohibited from entering into mergers. prevented from issuing excessive additional debt. required to perform regular maintenance on equipment pledged as collateral.
C is correct. Affirmative covenants require certain actions of the borrower. Requiring the company to perform regular maintenance on equipment pledged as collateral is an example of an affirmative covenant because it requires the company to do something. Negative covenants require that the borrower not take certain actions. Prohibiting the borrower from entering into mergers and preventing the borrower from issuing excessive additional debt are examples of negative covenants.
Intangible assets with finite useful lives mostly differ from intangible assets with infinite useful lives with respect to accounting treatment of: revaluation. impairment. amortization.
C is correct. An intangible asset with a finite useful life is amortized, whereas an intangible asset with an indefinite useful life is not.
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.
Compared with using the FIFO (first in, first out) method to account for inventory, during a period of rising prices, which of the following is most likely higher for a company using LIFO (last in, first out)? Current ratio Gross margin Inventory turnover
C is correct. During a period of rising prices, ending inventory under LIFO will be lower than that of FIFO and cost of goods sold higher; therefore, inventory turnover (Cost of goods sold/Average inventory) will be higher.
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.
An analyst is reviewing the property, plant, and equipment disclosure related to a company's warehouse. The company uses the International Financial Reporting Standards (IFRS) revaluation model. The analyst would least likely be able to determine: the carrying amount under the cost model. how the fair value was obtained. the original date of acquisition.
C is correct. IFRS does not require disclosure of the original date of acquisition.
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? Straight-line method. Units-of-production method. Double-declining balance method.
C is correct. If Martinez wants to minimize tax payments in the first year of the machine's life, he should use an accelerated method, such as the double-declining balance method.
During a period of rising inventory costs, a company decides to change its inventory method from FIFO to the weighted average cost method. Under the weighted average method, which of the following financial metrics will most likely be higher than under FIFO? Current ratio Number of days in inventory Debt-to-equity ratio
C is correct. If all else is held constant, in a period of rising costs the ending inventory will be lower under the weighted average cost method and the cost of goods sold will be higher (compared to FIFO), resulting in lower net income and retained earnings. There will be no impact on the debt level, current or long-term. Therefore, the debt-to-equity ratio (Total debt/Total shareholders' equity) will increase because of the decrease in retained earnings (and lower shareholders' equity).
Under US GAAP, which of the following would require the lessee to classify a lease as a capital lease? The term is 60% of the useful life of the asset. The lease contains an option to purchase the asset at fair value. The present value of the lease payments is 95% of the fair value.
C is correct. If the present value of the lease payments is greater than 90% of the fair value of the asset, the lease is considered a capital lease. A lease with a term that is 75% or more of the useful life of the asset is deemed to be a capital lease. The option to purchase the asset must be deemed to be cheap (bargain purchase option), not just include the option to purchase the asset.
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 depreciation 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: smaller. the same. greater.
C is correct. Shifting at the end of Year 2 from double-declining balance to straight-line depreciation methodology results in depreciation expense being the same in each of Years 3, 4, and 5. Shifting to the straight-line methodology at the beginning of Year 3 results in a greater depreciation expense in Year 4 than would have been calculated using the double-declining balance method.
The method used by a high-end custom-built motorcycle manufacturer to value its inventory results in the matching of the physical flow of the particular items sold, and the items remaining in inventory, to their actual cost. Which of the following inventory valuation methods is the manufacturer most likely using? FIFO Weighted average cost Specific identification
C is correct. Specific identification is the inventory method that results in the matching of the physical flow of the particular items sold and would be most suitable for high-end custom-built motorcycles that are not ordinarily considered interchangeable.
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.
The impairment of intangible assets with finite lives affects: the balance sheet but not the income statement. the income statement but not the balance sheet. both the balance sheet and the income statement
C is correct. The carrying amount of the asset on the balance sheet is reduced by the amount of the impairment loss, and the impairment loss is reported on the income statement.
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.
Regarding a company's debt obligations, which of the following is most likely presented on the balance sheet? Effective interest rate Maturity dates for debt obligations The portion of long-term debt due in the next 12 months
C is correct. The non-current liabilities section of the balance sheet usually includes a single line item of the total amount of a company's long-term debt due after 1 year, and the current liabilities section shows the portion of a company's long-term debt due in the next 12 months. Notes to the financial statements generally present the stated and effective interest rates and maturity dates for a company's debt obligations
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: straight line. units of production. double-declining balance.
C is correct. The operating income or earnings before interest and taxes will be lowest for the method that results in the highest depreciation expense. The double-declining balance method results in the highest depreciation expense in the first year of use.
Cinnamon, Inc. recorded a total deferred tax asset in Year 3 of $12,301, offset by a $12,301 valuation allowance. Cinnamon most likely: fully utilized the deferred tax asset in Year 3. 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.
Zimt AG wrote down the value of its inventory in 2017 and reversed the write-down in 2018. Compared to the ratios that would have been calculated if the write-down had never occurred, Zimt's reported 2017: 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 2017. 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.
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.)
Under US GAAP, which of the following is least likely a disclosure concerning inventory? The amount of inventories recognized as an expense during the period The carrying amounts of inventories carried at fair value less costs to sell The amount of the reversal of any write-down of inventories
C is correct. US GAAP does not permit the reversal of prior year write-downs; therefore, there are no disclosures related to reversals.
Which of the following is a required financial statement disclosure for long-lived intangible assets under US GAAP? The useful lives of assets The reversal of impairment losses Estimated amortization expense for the next five fiscal years
C is correct. Under US GAAP, companies are required to disclose the estimated amortization expense for the next five fiscal years. Under US GAAP, there is no reversal of impairment losses. Disclosure of the useful lives—finite or indefinite and additional related details—is required under IFRS.
Under US GAAP, when assets are acquired in a business combination, goodwill most likely arises from: contractual or legal rights. assets that can be separated from the acquired company. assets that are neither tangible nor identifiable intangible assets.
C is correct. Under both International Financial Reporting Standards (IFRS) and US GAAP, if an item is acquired in a business combination and cannot be recognized as a tangible asset or identifiable intangible asset, it is recognized as goodwill. Under US GAAP, assets arising from contractual or legal rights and assets that can be separated from the acquired company are recognized separately from goodwill.
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: net income. net operating income. other comprehensive income.
C is correct. When a company uses the fair value model to value investment property, changes in the fair value of the property are reported in the income statement—not in other comprehensive income.
Which costs incurred with the purchase of property and equipment are expensed? Delivery charges Installation and testing Training required to use the property and equipment
C is correct. When property and equipment are purchased, the assets are recorded on the balance sheet at cost. Costs for the assets include all expenditures required to prepare the assets for their intended use. Any other costs are expensed. Costs to train staff for using the machine are not required to prepare the property and equipment for their intended use, and these costs are expensed.
Zimt AG started business in 2017 and uses the FIFO method. During 2017, it purchased 45,000 units of inventory at €10 each and sold 40,000 units for €20 each. In 2018, it purchased another 50,000 units at €11 each and sold 45,000 units for €22 each. Its 2018 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 2018 depleted the 2017 inventory. Of the inventory purchased in 2018, 40,000 units were sold and 10,000 remain, valued at €11 each, for a total of €110,000.
