# liabilities (schweser exam q)

I don’t understand, how is the franchise capitalized, and amortized, but the franchise is not counted as debt. Does anyone know why is the franchise not counted as debt (which would presumably add \$10m - 2m amortization)? Selected information from Yorktown Corp.’s financial statements for the year ended December 31, 2004 was as follows (in millions): Accounts Payable 8 Long-term Debt 9 Common Stock 17 Retained Earnings 23 Total Liabilities & Equity 57 In 2004, Yorktown paid \$10 million cash to purchase a franchise. The franchise cost was fully expensed in 2004. If the company had elected to amortize the franchise cost over 5 years instead of expensing it, Yorktown’s total debt ratio (total debt-to-total capital) would: A) increase from 0.474 to 0.551. B) decrease from 0.298 to 0.262. C) decrease from 0.474 to 0.403. Your answer: C was incorrect. The correct answer was B) decrease from 0.298 to 0.262. Total capital equals total assets which must equal total liabilities and equity. Yorktown’s total debt ratio was ((\$8 + \$9) / \$57 =) 0.298. If the franchise cost were amortized, retained earnings would be increased \$8 million (\$10 cost less (\$10 / 5 =) \$2 million of amortization.) The total debt ratio would change to ((\$8 + \$9) / (\$57 + \$8) =) 0.262.

Franchise is an asset.

capitalise means that an expense becomes an asset and amortised/depreciated over time, an example of this would be rent, paid, but recorded as prepaid expense (an asset) and used over time.

In addition only B) makes sense - by elimination - in the first place the ratio was 0.298.

thanks folks, i made a balls of that one!

lzen5 capitalize is to add something to your assets like interest. making a prepaid expense is a deferred expense and does not involve capitalization since capitalization is usually for long term assets