Capitalization Cfa Level 1

Front 1

Capitalization/Expensing effect on CF, Leverage, profitability, and income variability

Back 1

Note: All answers in terms of Capitalizing firm in relation to expensing firm

Income variability = More Stable
Profitability = Higher for capitalizing firms as long as level of expenditures is increasing
CFO = Net CF not affected but balance between CFO and CFI is. Capitalized assets included in CFI and never flow through CFO, therefore, CFO is higher for capitalizing firms and CFI will be lower.
Leverage Ratios = Capitalizing firms have higher Equity and Assets balances, therefore, solvency rations (D/A, D/E) will appear better (Lower) for capitalizing firms.

Front 2

In the US, should interest costs on construction projects of long lived assets be expensed or capitalized?

Back 2

SFAS 34 requires the capitalization of interest costs incurred during the construction period (only if firm is leveraged). If no specific borrowing is clear, weighted average of firms debt is used to compute capitalized interest cost.

Front 3

When analyzing financial statement ratios, the following must be done to account for capitalized interest

Back 3

1. Capitalized interest should be added back to interest expense. This will reduce Net Income and distort classification of cash flows.
2.Interest capitalized as part of the cost of fixed assets will be reported as CFI and never CFO. In order to restore comparability with firms that do not capitalize interest, the amount of interest capitalized should be added back to CFI and subtracted from CFO.
3.Interest coverage ratio should be calculated with interest expense adjusted to add back capitalized interest.

Front 4

Capitalization decision: R&D costs

Back 4

SFAS 2 states that all R&D costs be expensed in the period in which they were incurred

IAS 9 accounts for the expensing of research costs but the capitalization of development cost when certain criteria are met.

Front 5

Capitalizatin decision: Patents and Copyrights

Back 5

All costs incurred with developing patents and copyrights are expensed. Only legal fees incurred in registering patents and copyrights can be capitalized. However, full aquisition costs are capitalized when these assets are purchased from other entities.

Front 6

Capitalizatin decision: Franchises and Licenses

Back 6

Person purchasing license of franshise must capitalize these costs

Front 7

Capitalization decision: Brands and Trademarks

Back 7

Costs of purchasing brands and trademarks are capitalized, however, internally created brands/trademarks cannot be capitalized

Front 8

Capitalization decision: Advertising costs

Back 8

Expensed as incurred

Front 9

Capitalization decision: Goodwill

Back 9

=Difference between cost of an aquired firm and the fair market value of that firm. Goodwill recognition is limited in US GAAP and most other accounting practices. Goodwill should be capitalized and impairment test should be run yearly.

Front 10

Capitalization decision: Computer software development costs

Back 10

SFAS 86 applies to software intended for sale or lease to others and requires that all costs be expensed as incurred. Once economic feasablity is assured, costs can be capitalized.

Front 11

If capitalized the following will be greater

Back 11

Current Net Income
Future income (increasing Cap ex)
Return on assets (initial)
CFO
Interest Coverage ratio

Front 12

If capitalized the following will be smaller

Back 12

Future income (decreasing Cap ex)
Debt to equity
Return on assets (future)
CFI

Front 13

Interest costs during construction are

Back 13

Capitalized and then once construcion is completed, amortized over the LIFE OF THE CONSTRUCTED ASSET