Dep. & Impairments: Concept Checker

  1. Give an example of an industry that would deplete their assets rather than depreciate or amortize. (As a bonus, is the supply elastic or inelastic, and does it represent a greater opportunity cost or economic rent!) 2) True or false? Accounting depreciation is a valuation process. Economic depreciation is an allocation process. 3) True or false? Annuity of sinking fund depreciation can be thought of as ‘decelerate depreciation’. Bonus: Is it allowed under GAAP? 4) True of false? Since depreciation is a non-cash expense, it has absolutely no impact on tax expense. 5) If a firm uses accelerated depreciation rather than straight line depreciation, which are the following is MOST likely? - They will report greater total assets in the early periods but total depreciation will be the same as under straight line depreciation - Extending the depreciable life of the asset will reduce the annual depreciation expense under accelerated depreciation but will have no impact on straight line depreciation - No salvage value is included in the calculation of accelerated depreciation when the double declining method is used. - If the depreciable life is 10 years, in the first year of depreciation under the SYD method, the numerator will be 10 and the denominator will be 45. 6) Which depreciation method would LEAST appropriate in an industry where manufacturing assets become obsolete in just a few years. - Double Declining Balance - Service Hours - Straight Line 7) The CFO of Disney recognizes that the acquired PIXAR brand is an immensely valuable intangible asset with a high probability of an extremely long value-generating life. As such, he decides to amortize that value over 100 years. After all, Disney has been around for nearly that long and the brand value has sustained. What has the CFO done incorrectly? 8) The Disney Board requests the CFO present at their next meeting. They are concerned with the accounting treatment of goodwill from the PIXAR transaction. In particularly, one board member questions the number of years over which the CFO has decided to amortize the goodwill. What is most likely wrong with the CFO’s treatment of the deal? 9) A company makes the decision to move from straight line to accelerated depreciation for all new assets acquired beginning next year. Next year, they plan to engage in significant capital expenditures – well in excess of their maintenance levels. What should the Company expect to see with regards to their operating margin? 10) A company has been tight on cash flow from operations the last few quarters. Would a move to straight line depreciation from their current accelerated schedule help or hurt their cash position? Why? 11) Which of the following requires prior year financials reported in the current year’s 10K be amended? - A change from SYD to straight line depreciation for all new assets - A change in estimate of the useful life for some existing assets - A change in the estimate of the salvage value for some existing assets - A change from straight line depreciation to SYF for all existing assets 12) Company reports depreciation expense of $45mm and accumulated depreciation of $340. What is the Average age of the existing assets? 13) True or false: Impairment must be recognized when the discounted present value of an asset is less the carrying value. 14) True or false: The amount of the impairment should equal the carrying cost less the fair market value. 15) True or false: If you impair an asset, you must make an adjustment to the related DTL on the balance sheet for the impaired portion of the asset. 16) Will asset impairments lead to a tax refund in the current period are the creation of a DTA?

Answers before lunch break! ---------------------------------- 1) Give an example of an industry that would deplete their assets rather than depreciate or amortize. (As a bonus, is the supply elastic or inelastic, and does it represent a greater opportunity cost or economic rent!) - Mining. - Supply will potentially be perfectly elastic for a non-renewable resource. Value is completely aligned to opportunity cost which determines the rate at which supply is provided to the market 2) True or false? Accounting depreciation is a valuation process. Economic depreciation is an allocation process. - Accounting deprecation is purely a systematic allocation process. - Econominc depreciation focuses on the valuation aspect of assets over time. 3) True or false? Annuity of sinking fund depreciation can be thought of as ‘decelerate depreciation’. Bonus: Is it allowed under GAAP? True. But it is not allowed under GAAP 4) True of false? Since depreciation is a non-cash expense, it has absolutely no impact on tax expense. Very false. Depreciation is a pre-tax expense on the income statement which directly impacts the amount of pre-tax income reported. Higher depreciation expense will result in lower taxes. Therefore, there is a definite cash impact to you depreciation method. 5) If a firm uses accelerated depreciation rather than straight line depreciation, which are the following is MOST likely? - No salvage value is included in the calculation of accelerated depreciation when the double declining method is used. 6) Which depreciation method would LEAST appropriate in an industry where manufacturing assets become obsolete in just a few years. - Service Hours. If asset become obsolete quickly, you will likely have to take a significant impairment charge if you use the service hours method. 7) The CFO of Disney recognizes that the acquired PIXAR brand is an immensely valuable intangible asset with a high probability of an extremely long value-generating life. As such, he decides to amortize that value over 100 years. After all, Disney has been around for nearly that long and the brand value has sustained. What has the CFO done incorrectly? - Intangible assets can only be amortized for 40 years. 8) The Disney Board requests the CFO present at their next meeting. They are concerned with the accounting treatment of goodwill from the PIXAR transaction. In particularly, one board member questions the number of years over which the CFO has decided to amortize the goodwill. What is most likely wrong with the CFO’s treatment of the deal? - Goodwill cannot be amortized. 9) A company makes the decision to move from straight line to accelerated depreciation for all new assets acquired beginning next year. Next year, they plan to engage in significant capital expenditures – well in excess of their maintenance levels. What should the Company expect to see with regards to their operating margin? - Next year, operating margin will probably decline as a direct result of the increase in depreciation expense. 10) A company has been tight on cash flow from operations the last few quarters. Would a move to straight line depreciation from their current accelerated schedule help or hurt their cash position? Why? - Moving to straight line depreciation would decrease the reported depreciation expense resulting in an increase in pre-tax income. This would result in higher cash taxes. As a result, the company would be even worse off. 11) Which of the following requires prior year financials reported in the current year’s 10K be amended? - A change from straight line depreciation to SYF for all existing assets Only the change in depreciation methodology for existing assets requires a restatement. Changes in estimates of salvage value or depreciable life result in prospective changes. 12) Company reports depreciation expense of $45mm and accumulated depreciation of $340. What is the Average age of the existing assets? 7.55 years (340/45) 13) True or false: Impairment must be recognized when the discounted present value of an asset is less the carrying value. False: You must recognized an impairment when the undiscounted cash flow value of an asset is less than the carrying value. 14) True or false: The amount of the impairment should equal the carrying cost less the fair market value. True. If fair market value is unknown, you may also use the DISCOUNTED present value of future cash flows 15) True or false: If you impair an asset, you must make an adjustment to the related DTL on the balance sheet for the impaired portion of the asset. True 16) Will asset impairments lead to a tax refund in the current period are the creation of a DTA? If the impairment is not deductible for income tax purposes, it will result in the creation of a DTA.

  1. Give an example of an industry that would deplete their assets rather than depreciate or amortize. (As a bonus, is the supply elastic or inelastic, and does it represent a greater opportunity cost or economic rent!) - non-renewable natural resource, supply is perfectly elastic, greater economic rent 2) True or false? Accounting depreciation is a valuation process. Economic depreciation is an allocation process. - false, accounting depreciation is a cost allocation process 3) True or false? Annuity of sinking fund depreciation can be thought of as ‘decelerate depreciation’. Bonus: Is it allowed under GAAP? - false, also forbidden under gaap 4) True of false? Since depreciation is a non-cash expense, it has absolutely no impact on tax expense. - false, it reduces net income and hence tax expenense 5) If a firm uses accelerated depreciation rather than straight line depreciation, which are the following is MOST likely? - No salvage value is included in the calculation of accelerated depreciation when the double declining method is used. 6) Which depreciation method would LEAST appropriate in an industry where manufacturing assets become obsolete in just a few years. - Straight Line 7) The CFO of Disney recognizes that the acquired PIXAR brand is an immensely valuable intangible asset with a high probability of an extremely long value-generating life. As such, he decides to amortize that value over 100 years. After all, Disney has been around for nearly that long and the brand value has sustained. What has the CFO done incorrectly? goodwill should not be amortized, only tested for impairment periodically 8) The Disney Board requests the CFO present at their next meeting. They are concerned with the accounting treatment of goodwill from the PIXAR transaction. In particularly, one board member questions the number of years over which the CFO has decided to amortize the goodwill. What is most likely wrong with the CFO’s treatment of the deal? need to test yearly for impairment, goodwill is not amortized 9) A company makes the decision to move from straight line to accelerated depreciation for all new assets acquired beginning next year. Next year, they plan to engage in significant capital expenditures – well in excess of their maintenance levels. What should the Company expect to see with regards to their operating margin? Operating margin = EBIT = decreased 10) A company has been tight on cash flow from operations the last few quarters. Would a move to straight line depreciation from their current accelerated schedule help or hurt their cash position? Why? possibly, if it reduces their income tax expense 11) Which of the following requires prior year financials reported in the current year’s 10K be amended? - A change from SYD to straight line depreciation for all new assets - A change from straight line depreciation to SYF for all existing assets 12) Company reports depreciation expense of $45mm and accumulated depreciation of $340. What is the Average age of the existing assets? 340/45 = 7.56 periods 13) True or false: Impairment must be recognized when the discounted present value of an asset is less the carrying value. undiscounted cash flows 14) True or false: The amount of the impairment should equal the carrying cost less the fair market value. false, undiscounted cash flows - book value 15) True or false: If you impair an asset, you must make an adjustment to the related DTL on the balance sheet for the impaired portion of the asset. true because it will reduce future depreciation expense 16) Will asset impairments lead to a tax refund in the current period are the creation of a DTA? false
  1. Oil extracting company. Elastic supply 2) False? 3) True. Not allowed. 4) False 5) C 6) Service hours? 7) Amortizing the goodwill. 8) It should be checked annually for impairment. No amortization should take place. 9) Decline in operating margin due to increase in depreciation expense. Expected to reverse when their capital expenditure slows/stops. 10) No effect. Assuming no change in tax return depreciation method. 11) B 12) 7.6yrs 13) False. Shouldn’t be discounted 14) True? 15) True? 16) False? I guess I need to review the income tax.