Reading 22 Long-Lived Assets - Answers

Ban $80 million gain on income statement and $10 million gain in other Study Session 7, Module 22.3, LOS 22.k Which of the following statements comparing straight-line depreciation metho

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Question #1 of 74 Question ID: 1378391

Slovac Company purchased a machine that has an estimated useful life of eight years for

$7,500 Its salvage value is estimated at $500

What is the depreciation expense for the second year, assuming Slovac uses the declining balance method of depreciation?

double-A) $1,406.

B) $1,438.

C) $1,875.

Explanation

double-declining balance depreciation rate = 2 × 1/8 = ¼ or 25%

first year deprecation will be $7,500 × 0.25 = $1,875

second year deprecation will be ($7,500 − $1,875) × 0.25 = $1,406

(Study Session 7, Module 22.2, LOS 22.d)

On January 1, 2004, JME purchased a truck that cost $24,000 The truck had an estimateduseful life of 5 years and $4,000 salvage value The amount of depreciation expense

recognized in 2006 assuming that JME uses the double declining balance method is:

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For a firm to use the revaluation model for balance sheet reporting of long-lived assets:

A) the rm must report under U.S GAAP.

B) an active market must exist for the assets.

C)the rm must choose which assets of each type to revalue, and which to report

at cost

Explanation

Under IFRS, a firm may use the revaluation model for long-lived assets that have an activemarket which can be used to determine the fair value of the assets The firm must use thesame model for all assets of a similar type U.S GAAP reporting firms must use the costmodel for long-lived assets

(Study Session 7, Module 22.3, LOS 22.h)

An analyst will most likely use the average age of depreciable assets to estimate the

(Study Session 7, Module 22.4, LOS 22.m)

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Marcel Inc is a large manufacturing company based in the U.S but also operating in severalEuropean countries Marcel has long-lived assets currently in use that are valued on thebalance sheet at $600 million This includes previously recognized impairment losses of $80million The original cost of the assets was $750 million The fair value of the assets wasdetermined in a professional appraisal to be $690 million Assuming that Marcel reportsunder U.S GAAP, the new appraisal of the assets' value most likely results in:

A) a $90 million gain in other comprehensive income.

B)an $80 million gain on income statement and $10 million gain in other

(Study Session 7, Module 22.3, LOS 22.k)

Which of the following statements comparing straight-line depreciation methods to

alternative depreciation methods is least accurate? Companies that use:

A)accelerated depreciation methods for tax purposes will decrease the amount of

taxes paid in early years

B)accelerated depreciation methods will have lower asset turnover ratios than if

they used straight line depreciation

C)straight-line depreciation methods will have higher book values for the assets

on the balance sheet than companies that use accelerated depreciation

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Davis Inc is a large manufacturing company operating in several European countries Davishas long-lived assets that are valued on the balance sheet at $600 million This includespreviously recognized revaluation losses of $80 million In the most recent accountingperiod, the fair value of these assets in an active market is $690 million Which of the

following entries will Davis record under the IFRS revaluation model?

A) Gain on income statement and a revaluation surplus.

B) Gain on income statement only.

C) Revaluation surplus only.

Explanation

Under IFRS, firms may choose to report long-lived assets at fair value Upward

revaluations are permitted and will result in a gain recognized on the income statement tothe extent it reverses a previously recognized loss Any excess is reported as a revaluationsurplus, a direct adjustment to equity In this case, the carrying value of the assets is $600million and the fair value is $690 million Of the $90 million excess of fair value over

carrying value, $80 million is recognized as a gain on the income statement to reverse the

$80 million loss that was previously recognized The remaining $10 million is recorded asrevaluation surplus in shareholders' equity

Which set of accounting standards requires firms to disclose estimated amortization

expense for the next five years on intangible assets?

A) Both IFRS and U.S GAAP.

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Lakeside Co recently determined that one of its processing machines has become obsoleteafter 7 years of use and, unexpectedly, has no salvage value The machine was being

depreciated over a useful economic life of 10 years Which of the following statements is

most consistent with this discovery?

A) Historically, economic depreciation was overstated in the nancial statements B) Historically, economic depreciation was understated in the nancial statements C) Lakeside Co will owe back taxes.

Explanation

Historically, economic depreciation was understated If an asset becomes obsolete and itsuseful life is less than expected, accounting methods for depreciation have understatedthe economic depreciation In addition, if there is no salvage value when positive salvagevalue was expected, the understatement problem is compounded

(Study Session 7, Module 22.2, LOS 22.g)

Under U.S GAAP, an asset is considered impaired if its book value is:

A) greater than the sum of its undiscounted expected cash ows.

B) less than its market value.

C) greater than the present value of its expected future cash ows.

Explanation

Under U.S GAAP, an asset is considered impaired when its book value is greater than thesum of the estimated undiscounted future cash flows from its use and disposal

For Further Reference:

(Study Session 7, Module 22.3, LOS 22.i)

CFA® Program Curriculum, Volume 3, page 356

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Question #11 of 74 Question ID: 1378439The revaluation model for investment property is permitted under:

A) IFRS, but not U.S GAAP.

B) neither IFRS nor U.S GAAP.

C) both IFRS and U.S GAAP.

Explanation

For long-lived assets classified as investment property, IFRS allows either the cost model

or the fair value model The revaluation model is permitted for long-lived assets that arenot classified as investment property U.S GAAP only permits the cost model for valuation

of lived assets and does not identify investment property as a specific subset of lived assets

long-(Study Session 7, Module 22.4, LOS 22.n)

A company that capitalizes costs instead of expensing them will have:

A) lower cash ows from operations and higher pro tability in early years.

B) higher income variability and higher cash ows from operations.

C) lower cash ows from investing and lower income variability.

Explanation

Capitalizing costs tends to smooth earnings and reduces investment cash flows It will alsoincrease cash flows from operations and increase profitability in the early years

(Study Session 7, Module 22.1, LOS 22.c)

A reconciliation of beginning and ending carrying values for each class of property, plant,and equipment is required for firms reporting under:

A) both U.S GAAP and IFRS.

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(Study Session 7, Module 22.4, LOS 22.l)

Which of the following is best estimated by the ratio of net PP&E to annual depreciationexpense?

A) Remaining useful life.

B) Average age.

C) Total useful life.

Explanation

Remaining useful life = ending net PP&E / annual depreciation expense

Which of these intangible assets is most likely to be amortized?

A) Purchased patent that will expire in the current period.

B) Purchased franchise right with a useful life of two years.

C) Internally developed trademark with a useful life of 20 years.

Explanation

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A purchased, identifiable intangible asset with a finite life is amortized over its useful life.Costs incurred to develop an intangible asset such as a trademark are expensed whenincurred A patent that expires in the current period will not provide future benefits andtherefore should not be recognized as an asset.

(Study Session 7, Module 22.1, LOS 22.b)

Taking an impairment of long-lived assets will result in:

A) a lower debt-to-equity ratio.

B) higher future return on assets.

C) higher deferred tax liabilities.

Explanation

In future years, less depreciation expense is recognized on the written-down asset,

resulting in higher net income and return on assets since ROA = NI/Total Assets Deferredtax liabilities related to the asset decrease because the impairment cannot be deductedfrom taxable income until the asset is sold or disposed of The debt-to-equity ratio

increases because equity decreases while debt is unchanged

(Study Session 7, Module 22.3, LOS 22.k)

The most likely result of increasing the estimated useful life of a depreciable asset is that:

A) asset turnover will increase.

B) net pro t margin will increase.

C) return on assets will decrease.

Explanation

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The longer the estimated useful life of an asset, the lower the annual depreciation

expense charged to operations Lower depreciation expense results in higher net income,profit margins, and contributions to shareholder's equity

(Study Session 7, Module 22.2, LOS 22.g)

Clampet Ltd reports under IFRS and reports certain assets on its balance sheet using therevaluation model Machinery purchased in 20X1 for £22,000 is revalued to £20,000 at theend of 20X2 At the end of 20X3, the fair value of the asset is £23,000 The most likely effect

of the change in value to £23,000 is to:

A) increase EBIT by £3,000.

B) increase EBIT by £2,000.

C) leave EBIT unchanged.

Explanation

Clampet may only recognize a gain on revaluation to the extent that it reverses the

previously recognized £2,000 loss The increase in asset value in excess of the previouslyrecognized loss will be recognized in equity as revaluation surplus

Meyer Investment Advisory and Smith Brothers Investments are operationally identicalexcept that Meyer capitalizes some costs that Smith expenses Compared to Smith, Meyer islikely to have:

A) higher debt/equity ratio and higher debt/assets ratio.

B) lower pro tability (ROA and ROE) in early years and higher in later years.

C) higher cash ows from operations and lower cash ow from investing.

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The net cash flow remains the same regardless of which accounting method is used Butcomponents of cash flows change and cash flows from operations will be higher whencosts are capitalized and lower when expensed On the other hand, cash flows from

investing will be lower when costs are capitalized and higher when expensed Compared

to firms expensing costs, firms that capitalize costs will have smaller debt to equity ratiosand higher initial ROAs, but lower ROAs in the future

A firm acquires investment property for €3 million and chooses the fair value model forfinancial reporting In Year 1 the market value of the investment property decreases by

€150,000 In Year 2 the market value of the investment property increases by €200,000 Onits financial statements for Year 2, the firm will recognize a:

A)€150,000 gain on its income statement and a €50,000 revaluation surplus in

shareholders’ equity

B) €150,000 increase in shareholders’ equity.

C) €200,000 gain on its income statement.

Explanation

Under the fair value model, all gains and losses from changes in the value of investmentproperty are recognized on the income statement The firm will recognize a loss of

€150,000 in Year 1 and a gain of €200,000 in Year 2

(Study Session 7, Module 22.4, LOS 22.n)

As part of a major restructuring of business units, General Security (an industrial

conglomerate operating solely in the U.S and subject to U.S GAAP) recognizes significantimpairment losses The Investor Relations group is preparing an informational packet forshareholders, employees, and the media Which of the following statements is least

accurate?

A)During the year of the write-downs, retained earnings and deferred taxes will

decrease

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B)The write-downs are reported as a component of income from continuing

operations

C)Write-downs taken on asset values can be reversed in later years if market

conditions improve

Explanation

Impairments cannot be restored under U.S GAAP Both remaining statements are correct

(Study Session 7, Module 22.3, LOS 22.i)

The amortized cost of a trademark is least likely to appear on a firm's balance sheet if thetrademark was:

A) developed internally.

B) obtained in the acquisition of another rm.

C) purchased from another rm.

Explanation

Costs of developing a trademark are expensed in the period incurred The value of atrademark can appear on the balance sheet if the trademark was purchased or obtained

in a business acquisition

Which of the following statements regarding capitalizing versus expensing costs is leastaccurate?

A) Capitalization results in higher pro tability initially.

B) Cash ow from investing is higher with expensing than with capitalization.

C) Total cash ow is higher with capitalization than expensing.

Explanation

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Total cash flow is higher with capitalization than expensing is least accurate because totalcash flow would be the same under both methods, not considering tax implications.

The average age of a firm's property, plant, and equipment can be estimated by dividing:

A) accumulated depreciation by depreciation expense.

B) gross PP&E by depreciation expense.

C) net PP&E by depreciation expense.

Explanation

Average age = accumulated depreciation / annual depreciation expense

Spenser Inc owns a piece of specialized machinery with a current fair value of $400,000 Theoriginal cost of the machinery was $500,000 and to date has generated accumulated

depreciation of $140,000 Which of the following must Spenser record on the income

statement if it decides to abandon the asset?

(Study Session 7, Module 22.3, LOS 22.j)

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Walsh Furniture has purchased a machine with a 7-year useful life for $250,000 At the end

of its life it will have an estimated salvage value of $15,000 Using the double-decliningbalance (DDB) method, depreciation expense in year 2 is closest to:

Accelerated depreciation methods for financial reporting are most likely to have which of thefollowing effects on a company's financial ratios during the early years of an asset's life?

A) Lower current ratio.

B) Higher asset turnover ratio.

C) Lower debt-to-equity ratio.

Explanation

Given the higher depreciation expense recorded in the early years under accelerateddepreciation methods, total assets will be lower, causing a higher asset turnover ratioversus straight-line

(Study Session 7, Module 22.2, LOS 22.e)

Q estion #28 of 74

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A building owned by a firm is most likely to be classified as investment property if:

A) the rm uses the building for its corporate headquarters.

B) the building is a manufacturing plant or distribution center.

C) space in the building is rented to other rms.

Explanation

Under IFRS, investment property is an asset that is owned for the purpose of earningincome from rentals, capital appreciation, or both

Blocher Company is evaluating the following methods of accounting for depreciation oflong-lived assets and inventory:

Depreciation: straight-line; double-declining balance (DDB)

Inventory: first in, first out (FIFO); last in, first out (LIFO)

Assuming a deflationary environment (prices are falling), which of the following

combinations will result in the highest net income in year 1?

(Study Session 7, Module 22.2, LOS 22.e)

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Mammoth, Inc reports under U.S GAAP Mammoth has begun a long-term project to

develop inventory control software for external sale On its financial statements, Mammothshould:

A) capitalize all costs of this project.

B) expense all costs of this project in the periods incurred.

C)expense all costs of this project until technological feasibility has been

Capitalizing interest costs related to a company's construction of assets for its own use is

required by:

A) U.S GAAP only.

B) both IFRS and U.S GAAP.

C) IFRS only.

Explanation

Both U.S GAAP and IFRS require companies to capitalize the interest that accrues duringthe construction of capital assets for their own use

(Study Session 7, Module 22.1, LOS 22.a)

When comparing the financial statement effects of expensing versus capitalizing an

expenditure, capitalizing will most likely result in which of the following effects in the yearsafter the expenditure is incurred?

A) Lower net income and higher return on assets.

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B) Higher net income and lower return on assets.

C) Lower net income and lower return on assets.

Explanation

In the years following the expenditures, capitalizing will result in depreciation being

deducted against net income, thereby resulting in a lower net income than expensing.Furthermore, capitalizing will increase total assets and cause ROA (net income / assets) to

be lower

Capitalized interest costs are typically reported in the cash flow statement as an outflowfrom:

A manufacturing firm shuts down production at one of its plants and offers the facility forrent Based on the market for similar properties, the firm determines that the fair value ofthe plant is €500,000 more than its carrying value If this firm uses the cost model for plantand equipment and the fair value model for investment property, should it recognize a gain

on its income statement?

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A)No, because the rm must continue to use the cost model for valuation of this

asset

B) Yes, because the plant will be reclassi ed as investment property.

C) No, because the increase in value does not reverse a previously recognized loss Explanation

According to IFRS, property held for the purpose of earning rental income is classified asinvestment property However, when a property is transferred from owner-occupied toinvestment property, a firm using the fair value model must treat any increase in theproperty's value as a revaluation That is, the firm may only recognize a gain on the

income statement to the extent that it reverses a previously recognized loss

A company is switching from straight-line depreciation to an accelerated method of

depreciation Assuming all other revenue and expenses are at the same levels for the nextperiod, switching to an accelerated method will most likely increase the company's:

A) xed asset turnover ratio.

B) total assets on the balance sheet.

C) net income/sales ratio.

Explanation

The use of an accelerated depreciation method will increase depreciation expenses early

in the asset's life The book value of the asset will be lower Fixed asset turnover ratio(sales/fixed assets) will increase, because the book value of the fixed assets will be lower.(Study Session 7, Module 22.2, LOS 22.e)

Compared to firms that expense costs, firms that capitalize expenses will have:

A) higher leverage ratios.

B) lower cash ow from operations.

C) lower variability of income.

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Firms that capitalize expenses have less variability of net income because the capitalizedexpense becomes an asset that is depreciated over years instead of all at once whichhappens when costs are expensed Capitalizing expenses will result in higher cash flowsfrom operations because capitalizing an expense becomes an investing cash flow instead

of an operating cash flow which occurs when expenditures are expensed Firms thatcapitalize expenses have lower leverage ratios because assets and equity are increased soany leverage ratio that have assets and equity in the denominator will decrease

La Crosse Partners LLC has a franchise agreement with Arnolds Crispy Fry that expires inseven years, but is renewable at each expiration date for a nominal fee If the franchiseagreement is initially valued at $60,000:

A)an accelerated amortization method is more appropriate than the straight-line

method

B) amortization expense in the sixth year will be zero.

C) amortization expense in the rst year will be one-seventh of $60,000.

Explanation

Because the franchise agreement is renewable for a nominal fee, it is treated as an

intangible asset with an indefinite life and therefore not amortized but tested for

impairment regularly

(Study Session 7, Module 22.2, LOS 22.f)

JME acquired an asset on January 1, 2004, for $60,000 cash At that time JME estimated theasset would last 10 years and have no salvage During 2006 JME estimated the remaining life

of the asset to be only three more years with a salvage value of $3,000 If JME uses straightline depreciation, what is the depreciation expense for 2006?

A) $15,000.

B) $12,000.

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C) $6,000.

Explanation

first two years = (60,000 − 0) / 10 = 6,000 per year

yr 2006 = (60,000 − 12,000 − 3,000) / 3 = 15,000

Felker Inc owns a piece of specialized machinery The original cost of the machinery was

$500,000 and to date it has accumulated depreciation of $140,000 Which of the followingwill Felker recognize on its income statement if it sells the machinery for $400,000?

(Study Session 7, Module 22.3, LOS 22.j)

Which of the following items is least likely an example of an intangible asset with an

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