FSAV4e Test Bank_Mod 06 073114. Module 6 Asset Recognition and Operating Assets

Learning Objectives – coverage by question True/False Multiple Choice Exercises Problems Essays LO1 – Describe accounting for accounts receivable and the importance of the allowance for uncollectible accounts in de ...

Learning Objectives – coverage by question True/False Multiple Choice Exercises Problems Essays LO1 – Describe accounting for accounts receivable and the importance of the allowance for uncollectible accounts in determining profit. LO2 – Explain accounting for inventories and assess the effects on the balance sheet and income statement from different inventory costing methods. LO3 – Describe accounting for property, plant and equipment and explain the impacts on profit and cash flows from depreciation methods, disposals and impairments. Module 6: Asset Recognition and Operating Assets True/False Topic: Accounts Receivable LO: 1 1. Accounts receivables (net) reported in the current asset section of a company’s balance sheet represents the total amount owed by customers within the next year. Answer: False Rationale: A company makes two representations when reporting A/R in the balance sheet. The first being that it expects to collect the amount reported on the balance sheet. The second is that it expects to collect within the next year. The company may not expect to collect the total amount owed by customers, thus, the statement is incorrect. Topic: Collectibility of Accounts Receivable LO: 1 2. In order to report accounts receivable, net, companies estimate the amount they do not expect to collect from their credit customers. Answer: True Rationale: Companies must report the amount of accounts receivable that they expect to collect. To do this, they estimate the amount they expect to not collect. Topic: Income Shifting LO: 1 3. Overestimating the allowance for uncollectible accounts receivable can shift income from the current period into one or more future periods. Answer: True Rationale: By overestimating current accounts receivable provisions, current income decreases because expenses are increased. However, due to the overestimation, future year provisions will need to decrease to compensate, thus increasing future profitability. Income has been shifted to future periods from the present. Topic: Bad Debt Expense LO: 1 4. The financial statement effects for uncollectible accounts occur when the company writes off the account because that is when all the uncertainty is resolved. Answer: False Rationale: Under GAAP, costs relating to anticipated bad debts expense are matched with sales in the period that the sales are recognized. Upon write-off, both the receivable and the allowance account are reduced, leaving net receivables unchanged. ©Cambridge Business Publishers, 2015 6-2 Financial Statement Analysis and Valuation, 4th EditionTopic: Manufacturing Costs in Inventory LO: 2 5. The three components of manufacturing costs are direct materials, direct labor, and manufacturing overhead. Answer: True Rationale: These three components make up the manufacturing cost for manufacturing companies. Topic: Inventory Costing and the Balance Sheet LO: 2 6. LIFO inventory costing yields more accurate reporting of the inventory balance on the balance sheet. Answer: False Rationale: LIFO assumes that the most recently purchased goods are sold, thus the cost of the oldest items remain in the inventory balance. Hence, the balance sheet reports inventories at less current costs. Topic: LIFO and FIFO Disclosures LO: 2 7. Companies using LIFO are required to disclose the amount at which inventory would have been reported had it used FIFO. Similarly, companies using FIFO are required to disclose what their inventory would have been if the company had used LIFO. Answer: False Rationale: Only the first sentence is true. The disclosure of the LIFO reserve is required for those companies using LIFO inventory costing. This disclosure allows analysts to adjust the balance sheet and income statement for LIFO effects when comparing LIFO and FIFO companies. Topic: FIFO Inventory Costing and Profit LO: 2 8. In general, in a period of falling prices, LIFO produces higher gross profits than FIFO. Answer: True Rationale: Gross profit is affected by the choice of inventory costing method. Specifically, in periods of rising costs and prices, FIFO produces higher gross profits then LIFO because lower- cost inventories (i.e., first inventories bought are first out) are matched against sales revenues at current market prices. The converse holds true in periods of falling prices. Topic: Inventory Turnover LO: 2 9. Increasing inventory turnover rate will improve profitability. Answer: False Rationale: Profitability depends on both turnover and profit margin on the inventory. A company could increase turnover by dropping prices to zero. Items would fly off the shelves, but that would mean no profit. Test Bank, Module 6 6-3Topic: Asset Impairment LO: 3 10. Impairment of long-term assets is determined by comparing the sum of the present value of the asset’s expected future cash flows to the asset’s net book value. Answer: False Rationale: Impairment of long-term assets is determined by comparing the sum of expected future (undiscounted) cash flows from the asset with its net book value. If the asset is deemed to be impaired, it is written down to its market value and the write-down is recorded as an expense in the income statement. Topic: Percent Used Up LO: 3 11. The percent used up ratio indirectly measures the likelihood of future capital expenditures that the company will have to make. Answer: True Rationale: Percent used up of plant assets is equal to accumulated depreciation divided by the cost of depreciable assets. If accumulated depreciation is high, the percent used up will be high, indicating that the equipment is nearing the end of its life cycle. New equipment will likely have to be purchased in the near future. Topic: Depreciation Assumptions LO: 3 12. In order to estimate depreciation expense using the double-declining-balance method, managers must estimate the asset’s useful life and its salvage value. Answer: False Rationale: Salvage value does not enter into the calculation of double-declining-balance method depreciation. Topic: Gains on Sale of Assets LO: 3 13. The gain or loss on the sale of the asset is computed by: Gain/(Loss) on sale = Market value of asset – Net book value of asset Answer: False Rationale: The correct equation involves the proceeds received, which may differ from the asset’s market value. Topic: Capitalization of Assets LO: 3 14. For self-constructed assets, a firm may capitalize any expenses required to place the asset in service. This includes any interest expense on loans during the construction period. Answer: True Rationale: A firm may capitalize any costs to construct the asset providing the costs bring future 6-4 Financial Statement Analysis and Valuation, 4th EditionTopic: Depreciation for Tax Purposes LO: 3 15. When a firm uses an accelerated method of depreciation for tax reporting in order to minimize its tax burden, it will not really save any tax dollars in the end because depreciation method merely changes the timing of the depreciation expenses but not the total. Answer: False Rationale: An accelerated method for taxes brings real savings. Paying lower taxes early on allows the company to reinvest the additional cash flows into additional operating assets. As well, the present value of a dollar of tax in the future is worth less than a dollar today.