Expensing versus Capitalizing
Companies can capitalize software development costs when the product is
“technologically feasible”. Some companies never capitalize their software costs – for
example, Microsoft.
Viderics, a software development company capitalizes those software costs allowed
under GAAP. The following information is taken from its financial statements.
a. If Viderics had not capitalized its software costs but expensed them instead what
would they have reported as software expense each year, assuming unamortized balance
of software costs was $35 in year X0?
b. What is the likely effect upon net income variability of expensing rather than
capitalizing software development costs?
c. How might income be manipulated under either of these two methods (expensing and
capitalizing)?
Determine the amount Guido Inc. will record as investment income in its income
statement under the three scenarios: Weiner is considered trading marketable equity
security (MES), available-for-sale (AFS) MES, or using cost method.
A. Option A
B. Option B
C. Option C
D. Option D
The treasurer of Simmons Corporation, a newly formed software company is trying to
ascertain Simmons cash flows for the next three months. Expected sales are:
50% of sales are made for cash. Simmons expects to receive 25% in the month
following the sale and 20% in the second month following the sale. The remaining 5%
are expected to be un-collectible. Gross margin is 20%, and purchases are made one
month prior to sale. Purchases are paid one month after received.
The cash inflows in March from sales will be:
A. $250.
B. $245.
C. $220.
D. None of the above
Cash Budgets
You are the treasurer of Hodgkiss Suppliers Corporation (HSC), a sporting goods
equipment distributor. You are trying to determine the cash flow needs for the company
for the first three months of 2006.
Other information:
– 50% of sales are on a cash basis, of the remaining 50% half is collected in the
following month and the other half two months later.
– All purchases are paid for in the following month.
– Selling, general, and administrative (S, G, & A) costs are fixed, and are paid as
incurred.
– Dividends payable in February are $20.
– Interest payment is due in March of $50.
– Minimum cash balance required is $10.
a. Estimate what if any, HSC requires in the way of additional external financing at the
beginning of January to ensure they have enough cash to maintain a $10 cash balance
through until the end of March.
b. If additional external financing is not available, name three approaches HSC might
use in order to avoid the need for external financing.
Which of the following combinations of accounting practices will lead to the highest
reported earnings in an inflationary environment?
A. Option A
B. Option B
C. Option C
D. Option D
Many of the postretirement health benefit plans offered by companies to their
employees are unfunded, while all of their pension plans have some degree of funding.
Which of the following statements is false?
A. There is no legal requirement to fund postretirement health benefits, but there are
legal requirements covering pension funding.
B. Contributions to pension plans are normally tax deductible, but contributions to
postretirement health plans are not tax deductible.
C. Funds contributed to a pension plan can be withdrawn at any time, but funds
contributed to a postretirement health plan cannot be withdrawn by law.
D. Taxes do not have to be paid on investment income earned by assets in pension plan,
but they do normally have to be paid on postretirement health plans.
Which of the following statements about the relationship between RNOA and ROCE is
correct?
A. ROCE is always greater than RNOA
B. ROCE is greater than RNOA, if RNOA is greater than after-tax cost of dividends
C. ROCE is greater than RNOA, if RNOA is greater than cost of debt
D. ROCE is greater than RNOA, if RNOA is greater than after-tax cost of debt
Which of the following statements is correct?
A. All other things being equal, the more efficiently a company utilizes its assets, the
greater will be its return on investment.
B. All other things being equal, if return on equity increases, the return on assets must
have also increased.
C. All other things being equal, if the number of days inventory held increases, the
return on assets will increase.
D. All other things being equal, if the gross margin decreases, the inventory turnover
must have increased.
Net income is expected to increase by 10% for the next year, and dividend payout ratio
is expected to remain constant. After 2006, retained earnings are expected to decrease to
zero. Using the residual income method what is the value per share of Rivaz stock as of
12/31/05?
A. $15.25
B. $15.16
C. $14.38
D. $13.77
The semi strong efficiency of market implies that:
A. stock prices fully reflect all inside information.
B. stock prices do not reflect information contained in past trading volume.
C. stock prices fully reflect all publicly available information.
D. stock prices fully reflect all information about future price changes.
Calculating COGS and Inventory under LIFO and FIFO
Donuld Company sells many products. Sol is one of its popular items. Below is an
analysis of the inventory purchases and sales of Sol for the month of September.
Donuld Company uses the periodic inventory system.
INSTRUCTIONS
a. Using the FIFO assumption, calculate the amount charged to cost of goods sold for
September. (Show computations)
b. Using the LIFO assumption, calculate the amount assigned to the inventory on hand
on September 30. (Show computations)
c. Calculate the LIFO reserve that would be reported in the company’s books on
September 30 if using LIFO.
Which of the following is not an equity valuation model?
A. Residual income model
B. Dividend discount model
C. Free cash flow to equity model
D. Payback period model
A profitable high-tech company would generally have:
A. high price-to-book ratio and high price-to-earnings ratio.
B. high price-to-book ratio and low price-to-earnings ratio.
C. low price-to-book ratio and high price-to-earnings ratio.
D. low price-to-book ratio and low price-to-earnings ratio.
Using the dividend discount model, assuming dividends grow at 10% per year for the
next two years and at 5% thereafter, what is the value per share of Rivaz Corporation at
12/31/05?
A. $16.61
B. $16.51
C. $16.42
D. $14.87
Which of the following information would not be filed with the SEC by a publicly
traded company?
A. 10-K report
B. Prospectus
C. Proxy statement
D. Tax return
Tecktroniks Company reported in its annual report software refinement expenses of $12
million, $15 million, and $18 million for fiscal years 2005, 2006, and 2007,
respectively. At the end of fiscal 2007, it had total assets of $140 million. Net income
was $20 million for fiscal 2007, and it had a marginal tax rate of 35%.
If software refinement had been capitalized each year and amortized over a three-year
period beginning in the year the cost was incurred, total assets at the end of fiscal 2007
would have been:
A. $185 million.
B. $172 million.
C. $158 million.
D. $157 million.
The statement of cash flows for Georgey Company for 2004 and 2005 is as follows:
Which of the following statements is correct?
A. Inventory was a use of cash for Georgey in 2005.
B. Current liabilities increased in 2005.
C. Georgey has a net outflow of cash in 2005.
D. Restructuring charges were a use of cash for Georgey in 2004.
Which of the following statements is incorrect?
A. Under GAAP, statements are prepared using accrual accounting.
B. Under GAAP, all assets are marked to market each accounting period.
C. Under GAAP, it is necessary to make certain estimates.
D. Annual statements submitted to the SEC (10-K) must be prepared using GAAP.
A U.S. company has a subsidiary located in Great Britain. If the U.S. dollar is the
functional currency and the British pound is appreciating relative to the dollar, what
will happen to the following ratios after remeasurement?
A. Option A
B. Option B
C. Option C
D. Option D
Which of the following statements best explains the difference in observed net
operating asset turnover?
A. Widget Co’s lower financial leverage
B. Widget Co uses FIFO and Tools uses LIFO
C. Widget Co’s lower tax rate
D. Widget Co has significant operating leases and Tool Inc. has no leases
Pro Forma Income Statements
Cars Inc. and Automobile Inc. are two car manufactures. Cars Inc. manufactures high
quality cars whereas Automobile Inc. manufactures lower end cars. Cars Inc. is more
capital intensive than Automobile Inc., and relies more on fixed assets for its
production. You are given the following information about the companies for year X1
(amounts in millions):
The car manufacturing industry expects the following increases in sales in the following
years (all compared to the previous year): year X2 2%, year X3 4%, year X4 3%, year
X5 2%.
a. Comment on the cost structure for both companies and on the likely effect of the cost
structure and type of cars manufactured on the price and gross margin of both
companies.
b. Prepare a forecast of Cars Inc. sales, COGS, gross margin for years X2 to X5 based
on the information given above.
c. Prepare a forecast of Automobile Inc. sales, COGS, gross margin for years X2 to X5
based on the information given above.
d. Comment on your results compared to your answer in part a.
SFAS prescribes that information about the level of inputs used for determining fair
values must be reported in the:
A. balance sheet.
B. director’s letter.
C. footnotes.
D. MD&A.
Which of the following statements about stock dividends is true?
A. Stock dividends increase the number of shares outstanding.
B. Stock dividends are more valuable than stock splits.
C. Stock dividends are recorded as a reduction in cash.
D. Stock dividends are dividends given in the form of stock from another company.
Which of the following statements concerning deferred taxes is correct?
A. Deferred taxes will not be found in the asset section of a balance sheet.
B. Deferred taxes arise from permanent differences in GAAP and tax accounting.
C. Deferred taxes will only decrease when a cash payment is made.
D. Deferred taxes arising from the depreciation of a specific asset will ultimately reduce
to zero as the item is depreciated.
A company’s current ratio is 1.5. If the company uses cash to retire notes payable due
within one year, would this transaction increase or decrease the current ratio and return
on assets ratio?
A. Current ratio: Increase; Return on assets: Increase
B. Current ratio: Increase; Return on assets: Decrease
C. Current ratio: Decrease; Return on assets: Increase
D. Current ratio: Decrease; Return on assets: Decrease
The correct cash flows from investing activities is:
A. ($41,000).
B. ($45,500).
C. ($48,000).
D. None of the above
If sales increased by 10% per annum for the next 20 years, sales for year 2025 would be
closest to:
A. $407,000.
B. $124,459.
C. $113,000.
D. $55,500.
When considering the determinants of the price-to-book ratio (PB) which of the
following is correct?
I. All other things being equal, the greater a company’s return on common stockholders’
equity, the greater the PB ratio.
II. All other things being equal, the greater a company’s cost of equity, the greater the
PB ratio.
III. If a company’s return on common stockholders’ equity equals its cost of equity, the
PB ratio should equal 1.
IV. The greater a company’s current earnings the higher the PB ratio.
A. I, III, and IV
B. I and III
C. II and IV
D. I and II
A profitable mature company would generally have:
A. high price-to-book ratio and high price-to-earnings ratio.
B. high price-to-book ratio and low price-to-earnings ratio.
C. low price-to-book ratio and high price-to-earnings ratio.
D. low price-to-book ratio and low price-to-earnings ratio.
Depreciation is based on the principle of:
A. allocation.
B. appropriation.
C. lower of cost or market.
D. approbation.
What is net cash flow from investing?
A. $11,000
B. $7,000
C. ($2,000)
D. ($12,000)