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Financial Accounting
Financial Accounting Unit 7
| Question | Answer |
|---|---|
| What does it mean to capitalize a cost? | To record it as a long-term asset because it provides benefit beyond the current period. |
| What does it mean to expense a cost? | To record it immediately on the income statement because it benefits only the current period or is uncertain. |
| What is the main criterion for capitalizing a cost? | The cost must provide probable future economic benefit and be measurable. |
| What happens to capitalized costs over time? | They are gradually written off through depreciation or amortization. |
| Why are employee wages expensed rather than capitalized? | Because they benefit only the current period. |
| Under U.S. GAAP, how are general R&D costs treated? | They are expensed because future benefits are uncertain. |
| When can software development costs be capitalized? | After technological feasibility is established. |
| Under IFRS, when can development costs be capitalized? | If the future benefit is probable and can be reliably measured. |
| What is the general rule for advertising costs? | Expense them unless they are direct-response ads with measurable future benefits. |
| What is the conservative accounting approach for uncertain costs? | Expense them to avoid overstating assets or income. |
| What does depreciation do in accounting? | Spreads the cost of a long-term asset over its useful life as an expense. |
| What method assumes assets wear out evenly over time? | The straight-line method. |
| What assets are commonly depreciated? | Buildings, equipment, and vehicles (not land). |
| What costs are included in the acquisition of a fixed asset? | Purchase price, sales tax, freight, installation, testing, and setup. |
| What is never depreciated? | Land |
| What is book value? | Original cost minus accumulated depreciation. |
| What is the formula for straight-line depreciation? | (Cost − Salvage Value) ÷ Useful Life. |
| What is salvage value? | The expected value of the asset at the end of its useful life. |
| In the straight-line method, how is depreciation expense affected year to year? | It stays the same each year. |
| What is the journal entry to record annual depreciation? | Debit Depreciation Expense; Credit Accumulated Depreciation. |
| Why use a contra asset account for depreciation? | To preserve the original asset cost and track total depreciation separately. |
| What does accumulated depreciation represent? | The total amount of depreciation recorded to date. |
| On the balance sheet, how is equipment presented? | At cost, minus accumulated depreciation = book value. |
| What accounting principle does depreciation follow? | The matching principle—matching asset cost to revenue earned. |
| What is the book value at the end of an asset’s useful life using straight-line depreciation? | It equals the estimated salvage value. |
| What are other depreciation methods besides straight-line? | Units of production and accelerated methods like double-declining balance. |
| Why is straight-line depreciation widely used? | It's simple, consistent, and easy to apply. |
| What does it mean to capitalize a cost? | To record it as an asset on the balance sheet and spread its cost over time through depreciation or amortization. |
| What does it mean to expense a cost? | To record it immediately on the income statement because it only benefits the current period or is uncertain. |
| When should a cost be capitalized? | When it provides a probable future economic benefit that extends beyond the current period. |
| When should a cost be expensed? | When its benefit is limited to the current period or is uncertain. |
| Give an example of a cost that should clearly be capitalized. | Purchase of a building, machinery, or land. |
| Give an example of a cost that should clearly be expensed. | Wages for current labor or office supplies used during the year. |
| Why are R&D costs generally expensed under U.S. GAAP? | Because their outcomes are uncertain and future benefits are hard to measure reliably. |
| Under U.S. GAAP, when can software development costs be capitalized? | After technological feasibility has been established. |
| How does IFRS treat research and development costs differently? | Research is expensed; development may be capitalized if future benefit is probable and measurable. |
| When can advertising be capitalized? | When it’s direct-response advertising with probable and measurable future benefit. |
| What is the general rule for accounting treatment of advertising costs? | Expense them immediately due to uncertain benefit. |
| What is the conservative approach when unsure about capitalizing or expensing a cost? | Expense it—to avoid overstating assets or income. |
| What is the financial reporting impact of capitalizing a cost? | Increases assets, delays expense recognition, and temporarily raises net income. |
| What is the financial reporting impact of expensing a cost? | Reduces net income immediately and does not overstate financial strength. |
| What’s a key question to ask when deciding between capitalizing and expensing? | Will the cost provide a measurable benefit beyond the current period? |
| What is the main idea behind accelerated depreciation methods? | They allocate more depreciation in the early years of an asset's life, reflecting faster loss of value. |
| How does accelerated depreciation differ from straight-line depreciation? | Accelerated depreciation front-loads expenses, while straight-line spreads cost evenly over the asset’s useful life. |
| What is the most common accelerated depreciation method? | Double-declining-balance (DDB) method. |
| What is the formula for calculating the straight-line rate? | Straight-line rate = 100% ÷ Useful Life |
| How do you calculate the DDB rate? | DDB rate = Straight-line rate × 2 |
| In declining-balance methods, what is depreciation based on? | A fixed percentage of the beginning book value for each year. |
| Why is salvage value ignored in early DDB calculations? | Because depreciation is based only on the book value each year; salvage value only limits the final depreciation amount. |
| What prevents book value from dropping below salvage value under DDB? | The depreciation in the final year is adjusted to stop at salvage value. |
| Why might a company use accelerated depreciation? | To match higher asset usage in early years and to reduce taxable income sooner. |
| What is MACRS used for? | It’s the tax depreciation system used in the U.S. to accelerate deductions for tax purposes. |
| What happens in the final year of DDB depreciation? | The expense is adjusted so the book value equals the salvage value. |
| What’s the formula for annual depreciation under DDB? | Depreciation = DDB rate × Beginning Book Value |
| What is the key limitation enforced in DDB calculations? | Depreciation must stop once book value equals salvage value. |
| What does PPE stand for? | Property, Plant, and Equipment. |
| What must be removed from the books when PPE is disposed of? | Both the original cost and accumulated depreciation. |
| What determines if a gain or loss is recorded on disposal? | Compare the asset’s book value with proceeds received. |
| What are the three methods of disposing PPE? | 1) Discard or scrap, 2) Sell, 3) Exchange for another asset. |
| When a fully depreciated asset is discarded, what is the journal entry? | Debit: Accumulated Depreciation Credit: Equipment (No gain or loss if no proceeds) |
| What is recorded if PPE is discarded before it’s fully depreciated and there’s a disposal cost? | A loss equal to book value plus disposal cost. |
| How do you record discarding PPE with a loss? | Debit: Accumulated Depreciation Debit: Loss on Disposal Credit: Equipment Credit: Cash (if disposal cost paid) |
| How is a gain recorded when a fully depreciated asset is sold? | Debit: Accumulated Depreciation Debit: Cash Credit: Equipment Credit: Gain on Sale |
| What is the formula to determine gain or loss on disposal? | Gain/Loss = Proceeds – Book Value |
| How do you calculate Book Value? | Book Value = Original Cost – Accumulated Depreciation |
| What is the journal entry when a partially depreciated asset is sold at a loss? | Debit: Accumulated Depreciation Debit: Cash Debit: Loss on Sale Credit: Equipment |
| When exchanging PPE, what value is used to record the new asset? | The fair market value of the asset received. |
| What triggers a gain in an asset exchange? | When the value received exceeds the book value. |
| Why do disposal gains or losses occur? | Because actual proceeds differ from book value due to estimation errors in depreciation. |
| What type of account is a gain on disposal? | A credit account (increases equity). |
| What type of account is a loss on disposal? | A debit account (reduces equity). |
| What is a trademark? | A legally protected brand identifier such as a name, logo, or slogan that distinguishes a company’s product or service. |
| Give three famous examples of trademarks. | Nike swoosh, Apple logo, Coca-Cola script. |
| How are internally developed trademarks treated in accounting? | Only legal registration costs are capitalized; the trademark itself is not recorded at market value. |
| Why isn’t the Coca-Cola script trademark on the balance sheet? | It was developed internally and thus isn’t recorded at market value. |
| When is a trademark recorded at fair market value? | When it is purchased from another company. |
| How are purchased trademarks reported? | As intangible assets at their purchase price or fair market value. |
| What is the journal entry to record a new trademark registration? | Debit: Trademark Credit: Cash |
| What is the journal entry when a trademark is purchased from another company? | Debit: Trademark Credit: Cash (for the amount paid) |
| Coca-Cola buys the Minute Maid trademark for $6.6 billion. What’s the journal entry? | Debit: Trademark $6,600,000,000 Credit: Cash $6,600,000,000 |
| Why are most trademark values not reflected on the balance sheet? | Because they are internally generated and only recorded at historical cost, not market value. |
| How are trademarks acquired through a business purchase treated? | Their fair value is allocated and recorded as part of the intangible assets acquired. |
| What conservative accounting principle is applied to internally developed trademarks? | They are recorded at historical cost, not market value, to avoid overstating asset values. |
| How is an internally generated trademark reported on the balance sheet? | Generally not reported, except for capitalized legal fees. |
| What is a patent? | A government-granted right that gives exclusive legal protection to use, sell, or license a new product, process, or idea for a specified time. |
| How long does patent protection typically last? | For a specified number of years, depending on the country and type of patent. |
| What must inventors do in exchange for patent protection? | Publicly disclose details of their invention. |
| How are internally developed patents accounted for? | Most development costs are expensed immediately; only legal and filing fees are capitalized. |
| Can legal defense costs for patents be capitalized? | Yes, only if the defense is successful. If not, the costs must be expensed. |
| How are purchased patents recorded in accounting? | At the purchase price or fair market value. |
| What happens to the value of patents acquired in a business purchase? | They are recorded at estimated fair market value on the acquiring company’s balance sheet. |
| What legal right does a patent owner have? | The right to prevent others from using, selling, or producing the invention for a certain period. |
| Why aren’t most internally developed patents recorded at full value? | Because they lack a clear, identifiable market cost. |
| What types of costs can be capitalized when developing a new patent? | Legal and filing fees, and successful legal defense costs. |
| What happens if a company fails to defend a patent in court? | Related costs must be expensed, and possibly written off. |
| Why are patents important in business acquisitions? | They can be a major intangible asset and are included in the acquirer’s financials at fair value. |
| What is a franchise? | A legal right to use another company's business model, branding, and methods for a specified number of years. |
| What rights does a franchise agreement typically grant? | The right to sell specific products/services and use the franchisor’s brand and systems. |
| How is a franchise recorded on the balance sheet? | At cost, including the purchase price and any directly related legal or setup fees. |
| Do increases in franchise value affect its book value? | No. The franchise asset remains recorded at historical cost regardless of market value. |
| What costs are included in the recorded cost of a franchise? | Initial franchise fee Legal fees Direct costs to acquire the franchise |
| Which legal right belongs to a franchise owner? | The right to use another company’s business ideas and brand for a set time. |
| Is a franchise considered an intangible asset? | Yes, it is recorded as an intangible asset on the balance sheet. |
| Why are franchises recorded at cost and not at estimated value? | To ensure conservative and reliable financial reporting based on verifiable costs. |
| What is amortization? | The process of allocating the cost of an intangible asset over its useful life. |
| Which types of assets are amortized? | Intangible assets with finite lives, such as patents, trademarks, and franchises. |
| What accounting method is typically used for amortization? | The straight-line method. |
| What is typically assumed about salvage value for intangible assets? | Salvage value is assumed to be zero unless strong evidence suggests otherwise. |
| How are intangible assets recorded initially? | At historical cost. |
| What is the journal entry to record amortization? | Debit: Amortization Expense Credit: Intangible Asset (or Accumulated Amortization) |
| What is the difference between depreciation and amortization? | Depreciation applies to tangible assets; amortization applies to intangible assets. |
| When should you amortize an intangible asset? | Only if it has a finite useful life. |
| How are intangible assets with indefinite lives treated? | They are not amortized until a finite life can be determined. |
| What triggers an impairment of an intangible asset? | A significant drop in value, such as revocation of a license or invalidation of a patent. |
| When is a contra-asset account used for amortization? | Sometimes, but many companies credit the intangible asset directly. |
| What happens if an intangible asset becomes impaired? | An impairment loss must be recorded. |
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heavenlypure
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