Module 6
Asset Recognition and
Operating Assets
Learning Objectives – coverage by question
True/FalseMultiple Exercises Problem Essays
Choice s
LO1– Describe accounting
for accounts receivable
the importance of
and 1- 1- 1- 1- 1, 2
allowance
the for
accounts in
uncollectible 4 8 7 4
profi
determining
t.
LO2– Explain accounting for
inventories and assess the
effects on the balance 5- 9- 8- 5- 3
and
sheetincome statement
different
from inventory 9 19 15 7
methods
costing
.
LO3– Describe accounting
for property, plant
equipment
and and explain
impacts
the on profit and 10- 20- 16- 8- 4, 5
flows
cash from 15 26 21 10
methods,
depreciationdisposals and
impairment
s.
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
©Cambridge Business Publishers, 2015
Test Bank, Module 6 6-1
, 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.
Topic: 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
©Cambridge Business Publishers, 2015
6-2 Financial Statement Analysis and Valuation, 4th Edition
,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.
Topic: 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
©Cambridge Business Publishers, 2015
Test Bank, Module 6 6-3
, 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 expected
benefits.
Topic: 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.
©Cambridge Business Publishers, 2015
6-4 Financial Statement Analysis and Valuation, 4th Edition
Asset Recognition and
Operating Assets
Learning Objectives – coverage by question
True/FalseMultiple Exercises Problem Essays
Choice s
LO1– Describe accounting
for accounts receivable
the importance of
and 1- 1- 1- 1- 1, 2
allowance
the for
accounts in
uncollectible 4 8 7 4
profi
determining
t.
LO2– Explain accounting for
inventories and assess the
effects on the balance 5- 9- 8- 5- 3
and
sheetincome statement
different
from inventory 9 19 15 7
methods
costing
.
LO3– Describe accounting
for property, plant
equipment
and and explain
impacts
the on profit and 10- 20- 16- 8- 4, 5
flows
cash from 15 26 21 10
methods,
depreciationdisposals and
impairment
s.
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
©Cambridge Business Publishers, 2015
Test Bank, Module 6 6-1
, 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.
Topic: 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
©Cambridge Business Publishers, 2015
6-2 Financial Statement Analysis and Valuation, 4th Edition
,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.
Topic: 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
©Cambridge Business Publishers, 2015
Test Bank, Module 6 6-3
, 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 expected
benefits.
Topic: 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.
©Cambridge Business Publishers, 2015
6-4 Financial Statement Analysis and Valuation, 4th Edition
