I’m not sure if I’m just not reading this right or if Q-bank is wrong, but I wanted to see what everyone else thinks. It seemed pretty straightforward to me but I got it wrong. What do you think the right answer is and why? Which of the following statements regarding firms that capitalize versus expense costs is least accurate? A) Cash flow from financing is the same whether costs are capitalized or expensed. B) Costs of acquiring a trademark by purchasing it are capitalized. C) Firms that capitalize costs initially have lower profitability ratios compared to expensing firms. D) Marketing costs related directly to sales are capitalized.
I have not reached FSA yet (I just finished ethics) but I’ll give it a try from what I remember from the one accounting course I took… A) ?? B) When you acquire a trademark it adds to your assets in terms of goodwill. C) Firms that capitalize costs instead of writing them down as expenses will have HIGHER profitability ratios D) Marketing costs are expenses I think the answer is D. I am looking forward to hearing the real answer
I would have guessed D as well.
Also think the answer is D. A.) Cash flow shouldn’t be affected B.) This is true. Acquisition costs are capitalized to the BV of the acquired asset or capitalized as goodwill. C.) Capitalizing --> Less exp --> higher NI --> higher profitability D.) Sales and marketing costs are expensed in the period incurred; NOT capitalized. I think the only way to capitalize marketing costs is if you prepaid for a marketing service. If I signed a 2 year agreement with a marketing firm, I would capitalize the cost and expense periodically over the life of the contract. But generally speaking, marketing costs should be expensed as incurred.
Least accurate: C Firms that capitalize costs initially have lower profitability ratios compared to expensing firms. Initially firms that capitalize have higher profitability ratios since they record less expenses
Answer: C The firms that capitalize cost will have lower expense than they would If they expense the complete cost as incurred at inception, so since the expenses are low initially, we have higher Net income and probably higher profits initially but option C quotes the exact opposite and hence the least accurate. There might be a case where the sales-person picks up the phone, cold-calls clients and starts marketing their products, so interested clients would book the consignment right away, probably that is when we can capitalise the cost of advertising/marketing. But this is just my viewpoint and my perception about all this could be wrong. - Dinesh S
Alright, C makes sense. But, aren’t marketing costs supposed to be expensed… thus making D a possible answer?
Yeah. I would agree with the explanations for C but I still think the D answer is suspect.
CFAI book states that advertising expenses that can be directly linked to sales are capitalized
You print up a six month supply of marketing brochures on 10/31. Capitalize with half expense this year, half expensed next year.
alpenchev Wrote: ------------------------------------------------------- > Least accurate: C > Firms that capitalize costs initially have lower > profitability ratios compared to expensing firms. > Initially firms that capitalize have higher > profitability ratios since they record less > expenses wow, you are right i even said the same thing in my first post but for some reason i concluded that it’s D i better not be this retarded on the actual exam
Hmmm… You have to be really careful capitalizing marketing costs. Remember when AOL got burned for that and took a huge charge? The “directly linked to sales” means something like suppose that you give someone free t-shirts with your gym logo on it if they sign up for a twelve month membership. You could capitalize the cost of the t-shirts and write them off over 12 months. I think there are narrow situations in which it is okay, but generally marketing costs are expensed unless they are directly linked to particular sales probably with a definable income stream from the sale. Edit: But the answer is clearly C because it’s way wrong.
Ok, I’m glad I’m not the only one that was thrown off! The correct answer was C) Firms that capitalize costs initially have lower profitability ratios compared to expensing firms. Reasons: A) Cash flow from financing is not affected by the expensing or capitalizing decision only cash flow from operations and cash flow from investing. B) Brands and trademarks if acquired in arm’s-length transactions may be capitalized. C) In the early years, firms that expense costs will have lower profitability ratios such as return on assets (ROA) and return on equity (ROE). In later years as growth subsides, expensing firms will have lower asset and equity balances and hence higher profitability measures such as ROA and ROE. D) Marketing costs that are NOT directly related to sales are expensed when incurred but marketing costs directly related to sales are capitalized.