After completing this chapter, you will be able to do the following:
Purchase price | $12,980 |
Freight and insurance | $1,200 |
Installation | $700 |
Testing | $100 |
Maintenance staff training costs | $500 |
The total cost of the machine to be shown on JOOVI's balance sheet is closest to:
Borrowing date | 1 January 2009 |
Amount borrowed | 500 million Brazilian real (BRL) |
Annual interest rate | 14 percent |
Term of the loan | 3 years |
Payment method | Annual payment of interest only. Principal amortization is due at the end of the loan term. |
The construction of the plant takes two years, during which time BAURU earned BRL 10 million by temporarily investing the loan proceeds. Which of the following is the amount of interest related to the plant construction (in BRL million) that can be capitalized in BAURU's balance sheet?
Which of these assets is an intangible asset with a finite useful life?
Product Patent | Copyright | Goodwill | |
A. | Yes | Yes | No |
B. | Yes | No | No |
C. | No | Yes | Yes |
Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Total | |
Units of production | 2,000 | 2,000 | 2,000 | 2,000 | 2,500 | 10,500 |
Compared with the units-of-production method of depreciation, if the company uses the straight-line method to depreciate the equipment, its net income in Year 1 will most likely be:
The following information relates to Questions 7 and 8.
Miguel Rodriguez of MARIO, S.A., an Uruguayan corporation, is computing the depreciation expense of a piece of manufacturing equipment for the fiscal year ended 31 December 2009. The equipment was acquired on 1 January 2009. Rodriguez gathers the following information (currency in Uruguayan pesos, UYP):
Cost of the equipment | UYP 1,200,000 |
Estimated residual value | UYP 200,000 |
Expected useful life | 8 years |
Total productive capacity | 800,000 units |
Production in FY 2009 | 135,000 units |
Expected production for the next 7 years | 95,000 units each year |
Acquisition cost | 2,300,000 |
Acquisition date | 1 January 2008 |
Expected residual value at time of acquisition | 500,000 |
The customer list is expected to result in extra sales for three years after acquisition. The present value of these expected extra sales exceeds the cost of the list. |
If the analyst uses the straight-line method, the amount of accumulated amortization related to the customer list as of 31 December 2009 is closest to:
Acquisition cost | 5,800,000 |
Acquisition date | 1 January 2009 |
Patent expiration date | 31 December 2015 |
Total plant capacity of patented product | 40,000 units per year |
Production of patented product in fiscal year ended 31 December 2009 | 20,000 units |
Expected production of patented product during life of the patent | 175,000 units |
If the analyst uses the units-of-production method, the amortization expense on the patent for fiscal year 2009 is closest to:
Fair value | £16,800,000 |
Costs to sell | £800,000 |
Value in use | £14,500,000 |
Net carrying amount | £19,100,000 |
The amount of the impairment loss on WLP Corp.'s income statement related to its manufacturing equipment is closest to:
Acquisition cost of the vehicle | ARP 100,000 |
Acquisition date | 1 January 2007 |
Estimated residual value at acquisition date | ARP 10,000 |
Expected useful life | 9 years |
Depreciation method | Straight-line |
The result of the sale of the vehicle is most likely:
The following information relates to Questions 23 through 28.1
Melanie Hart, CFA, is a transportation analyst. Hart has been asked to write a research report on Altai Mountain Rail Company (AMRC). Like other companies in the railroad industry, AMRC's operations are capital intensive, with significant investments in such long-lived tangible assets as property, plant, and equipment. In November of 2008, AMRC's board of directors hired a new team to manage the company. In reviewing the company's 2009 annual report, Hart is concerned about some of the accounting choices that the new management has made. These choices differ from those of the previous management and from common industry practice. Hart has highlighted the following statements from the company's annual report:
Statement 1: | “In 2009, AMRC spent significant amounts on track replacement and similar improvements. AMRC expensed rather than capitalized a significant proportion of these expenditures.” |
Statement 2: | “AMRC uses the straight-line method of depreciation for both financial and tax reporting purposes to account for plant and equipment.” |
Statement 3: | “In 2009, AMRC recognized an impairment loss of 50 million on a fleet of locomotives. The impairment loss was reported as ‘other income' in the income statement and reduced the carrying amount of the assets on the balance sheet.” |
Statement 4: | “AMRC acquires the use of many of its assets, including a large portion of its fleet of rail cars, under long-term lease contracts. In 2009, AMRC acquired the use of equipment with a fair value of 200 million under 20-year lease contracts. These leases were classified as operating leases. Prior to 2009, most of these lease contracts were classified as finance leases.” |
Exhibits A and B contain AMRC's 2009 consolidated income statement and balance sheet. AMRC prepares its financial statements in accordance with International Financial Reporting Standards.
EXHIBIT A Consolidated Statement of Income
2009 | 2008 | |||
For the years ended 31 December | in millions | % Revenues | in millions | % Revenues |
Operating revenues | 2,600 | 100.0% | 2,300 | 100.0% |
Operating expenses | ||||
Depreciation | (200) | (7.7%) | (190) | (8.3%) |
Lease payments | (210) | (8.1%) | (195) | (8.5%) |
Other operating expense | (1,590) | (61.1%) | (1,515) | (65.9%) |
Total operating expenses | (2,000) | (76.9%) | (1,900) | (82.6%) |
Operating income | 600 | 23.1% | 400 | 17.4% |
Other income | (50) | (1.9%) | — | 0.0% |
Interest expense | (73) | (2.8%) | (69) | (3.0%) |
Income before taxes | 477 | 18.4% | 331 | 14.4% |
Income taxes | (189) | (7.3%) | (125) | (5.4%) |
Net income | 288 | 11.1% | 206 | 9.0% |
EXHIBIT B Consolidated Balance Sheet
2009 | 2008 | |||
As of 31 December | in millions | % Assets | in millions | % Assets |
Assets | ||||
Current assets | 500 | 9.4% | 450 | 8.5% |
Property & equipment: | ||||
Land | 700 | 13.1% | 700 | 13.2% |
Plant & equipment | 6,000 | 112.1% | 5,800 | 109.4% |
Total property & equipment | 6,700 | 125.2% | 6,500 | 122.6% |
Accumulated depreciation | (1,850) | (34.6%) | (1,650) | (31.1%) |
Net property & equipment | 4,850 | 90.6% | 4,850 | 91.5% |
Total assets | 5,350 | 100.0% | 5,300 | 100.0% |
Liabilities and Shareholders' Equity | ||||
Current liabilities | 480 | 9.0% | 430 | 8.1% |
Long-term debt | 1,030 | 19.3% | 1,080 | 20.4% |
Other long-term provisions and liabilities | 1,240 | 23.1% | 1,440 | 27.2% |
Total liabilities | 2,750 | 51.4% | 2,950 | 55.7% |
Shareholders' equity | ||||
Common stock and paid-in-surplus | 760 | 14.2% | 760 | 14.3% |
Retained earnings | 1,888 | 35.3% | 1,600 | 30.2% |
Other comprehensive losses | (48) | (0.9%) | (10) | (0.2%) |
Total shareholders' equity | 2,600 | 48.6% | 2,350 | 44.3% |
Total liabilities & shareholders' equity | 5,350 | 100.0% | 5,300 | 100.0% |
The following information relates to Questions 29 through 35.2
Brian Jordan is interviewing for a junior equity analyst position at Orion Investment Advisors. As part of the interview process, Mary Benn, Orion's Director of Research, provides Jordan with information about two hypothetical companies, Alpha and Beta, and asks him to comment on the information on their financial statements and ratios. Both companies prepare their financial statements in accordance with International Financial Reporting Standards (IFRS) and are identical in all respects except for their accounting choices.
Jordan is told that at the beginning of the current fiscal year, both companies purchased a major new computer system and began building new manufacturing plants for their own use. Alpha capitalized and Beta expensed the cost of the computer system; Alpha capitalized and Beta expensed the interest costs associated with the construction of the manufacturing plants. In mid-year, both companies leased new office headquarters. Alpha classified the lease as an operating lease, and Beta classified it as a finance lease.
Benn asks Jordan, “What was the impact of these decisions on each company's current fiscal year financial statements and ratios?”
Jordan responds, “Alpha's decision to capitalize the cost of its new computer system instead of expensing it results in lower net income, lower total assets, and higher cash flow from operating activities in the current fiscal year. Alpha's decision to capitalize its interest costs instead of expensing them results in a lower fixed asset turnover ratio and a higher interest coverage ratio. Alpha's decision to classify its lease as an operating lease instead of a finance lease results in higher net income, higher cash flow from operating activities, and stronger solvency and activity ratios compared to Beta.”
Jordan is told that Alpha uses the straight-line depreciation method and Beta uses an accelerated depreciation method; both companies estimate the same useful lives for long-lived assets. Many companies in their industry use the units-of-production method.
Benn asks Jordan, “What are the financial statement implications of each depreciation method, and how do you determine a company's need to reinvest in its productive capacity?”
Jordan replies, “All other things being equal, the straight-line depreciation method results in the least variability of net profit margin over time, while an accelerated depreciation method results in a declining trend in net profit margin over time. The units-of-production can result in a net profit margin trend that is quite variable. I use a three-step approach to estimate a company's need to reinvest in its productive capacity. First, I estimate the average age of the assets by dividing net property, plant, and equipment by annual depreciation expense. Second, I estimate the average remaining useful life of the assets by dividing accumulated depreciation by depreciation expense. Third, I add the estimates of the average remaining useful life and the average age of the assets in order to determine the total useful life.”
Jordan is told that at the end of the current fiscal year, Alpha revalued a manufacturing plant; this increased its reported carrying amount by 15 percent. There was no previous downward revaluation of the plant. Beta recorded an impairment loss on a manufacturing plant; this reduced its carrying by 10 percent.
Benn asks Jordan “What was the impact of these decisions on each company's current fiscal year financial ratios?”
Jordan responds, “Beta's impairment loss increases its debt to total assets and fixed asset turnover ratios, and lowers its cash flow from operating activities. Alpha's revaluation increases its debt to capital and return on assets ratios, and reduces its return on equity.”
At the end of the interview, Benn thanks Jordan for his time and states that a hiring decision will be made shortly.
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