1) When capitalizing a long-lived asset, which of the following ARE NOT included in the capitalized amount?
- Overhead
- Freight and insurance in delivering asset
- Maintenance and repair
- Sales Tax
2) A firm will show smoother net income when costs are capitalized. Over time, will the variance in net income between firms that capitalize costs and firms that expenses costs increases or decrease? Will net income variability between expensing and capitalizing be greater for larger or smaller firms?
3) True or false? Expensing will result in lower profitability in absolute terms (e.g. net income) but will not result in lower profitability ratios (ROA/ROE) in all situations.
4) True or false? If the firm is experiencing negative growth (depreciation > capex), expensing will still result in lower profitability?
5) An analyst makes the following statements.
i) "When a firm capitalizes a cost, it create a shift from CFO to CFI. As a result, reported CFO is greater than a firm that expenses costs and CFI is lower than a firm that expenses costs. However, over time, this shift of expenditures from CFO to CFI will reverse as the capitalized assets amortize"
ii) "While the shift of cash flow from CFO to CFI nets to zero, there is a real cash benefit from capitalizing costs as income taxes are lower. This results in greater net income for a capitalizing firm"
6) The CFO of a company has an outstanding term loan with a leverage (debt/assets) covenant that must be under 1.5x at the end of the year. In September, he notices that the company has already tripped their covenant by a small margin. Ethical considerations aside, should he capitalize or expense costs for the remaining quarter to bring the covenant back into compliance?
7) True or False? IFRS requires the capitalization of interest costs incurred in construction of a new asset because the total cost of self constructed assets should equal their market cost at acquisition.
8) CFA states that the capitalization of interest for all firms is not logical because the financing costs associated with different firms can vary dramatically and the company's leverage should not impact the value of the constructed asset. All of the following adjustments should be made to a firm that capitalizes interest expense. What key step has been excluded regarding cash flows?
- Add capitalized interest expense back to the income statement
- Reduce net income by the interest expense
- Subtract interest expense from CFO thereby reducing CFO.
9) All of the following are challenges of valuing internally created intangible assets EXCEPT?
- Costs of creating assets may not be easily separable from other firm operations
- Duration of benefit can be hard to estimate
- Intangible assets are more valuable to the firm that created them than they are to other firms and will not realize fair value when sold.
- There may be little relationship between the cost to create such assets and their ultimate value.
10) True or false? Firms must always expense research costs but can sometimes capitalize development costs
11) True of false? Patents are highly valuable to a firm an are capitalizable. However, the legal fees and patent costs must be expensed.
12) Which is the only type of advertising cost that can be capitalized? Bonus: Why can it be capitalized?
13) True or false? The easiest, least controversial type of intangible that is capitalized are those which are purchase at fair market value from a third party in an arms-length transaction?
14) What must be established for software development costs to be capitalized?
- Overhead
- Freight and insurance in delivering asset
- Maintenance and repair
- Sales Tax
2) A firm will show smoother net income when costs are capitalized. Over time, will the variance in net income between firms that capitalize costs and firms that expenses costs increases or decrease? Will net income variability between expensing and capitalizing be greater for larger or smaller firms?
3) True or false? Expensing will result in lower profitability in absolute terms (e.g. net income) but will not result in lower profitability ratios (ROA/ROE) in all situations.
4) True or false? If the firm is experiencing negative growth (depreciation > capex), expensing will still result in lower profitability?
5) An analyst makes the following statements.
i) "When a firm capitalizes a cost, it create a shift from CFO to CFI. As a result, reported CFO is greater than a firm that expenses costs and CFI is lower than a firm that expenses costs. However, over time, this shift of expenditures from CFO to CFI will reverse as the capitalized assets amortize"
ii) "While the shift of cash flow from CFO to CFI nets to zero, there is a real cash benefit from capitalizing costs as income taxes are lower. This results in greater net income for a capitalizing firm"
6) The CFO of a company has an outstanding term loan with a leverage (debt/assets) covenant that must be under 1.5x at the end of the year. In September, he notices that the company has already tripped their covenant by a small margin. Ethical considerations aside, should he capitalize or expense costs for the remaining quarter to bring the covenant back into compliance?
7) True or False? IFRS requires the capitalization of interest costs incurred in construction of a new asset because the total cost of self constructed assets should equal their market cost at acquisition.
8) CFA states that the capitalization of interest for all firms is not logical because the financing costs associated with different firms can vary dramatically and the company's leverage should not impact the value of the constructed asset. All of the following adjustments should be made to a firm that capitalizes interest expense. What key step has been excluded regarding cash flows?
- Add capitalized interest expense back to the income statement
- Reduce net income by the interest expense
- Subtract interest expense from CFO thereby reducing CFO.
9) All of the following are challenges of valuing internally created intangible assets EXCEPT?
- Costs of creating assets may not be easily separable from other firm operations
- Duration of benefit can be hard to estimate
- Intangible assets are more valuable to the firm that created them than they are to other firms and will not realize fair value when sold.
- There may be little relationship between the cost to create such assets and their ultimate value.
10) True or false? Firms must always expense research costs but can sometimes capitalize development costs
11) True of false? Patents are highly valuable to a firm an are capitalizable. However, the legal fees and patent costs must be expensed.
12) Which is the only type of advertising cost that can be capitalized? Bonus: Why can it be capitalized?
13) True or false? The easiest, least controversial type of intangible that is capitalized are those which are purchase at fair market value from a third party in an arms-length transaction?
14) What must be established for software development costs to be capitalized?