MCQ Quiz

<h3>First Principles Thinking: Identifiability–Control–Benefits</h3><p><strong>B is correct.</strong> From first principles, an intangible asset can only be recognized when it represents a future economic resource the entity can both point to and control. IFRS embeds this logic through three criteria: identifiability (the asset is separable or arises from contractual/legal rights), control (the firm can restrict others’ access to the benefit), and probability of future economic benefits. If these conditions fail, the asset cannot be capitalized because it lacks the essential qualities of an economic resource. Applying this to the question, option B directly matches all three IFRS requirements.</p><p>A is incorrect because legal protection alone does not guarantee control or future benefits. A trademark can have a long legal life but still fail to meet recognition criteria if benefits are uncertain.</p><p>C is incorrect because internal development is not required for recognition; purchased intangible assets also qualify, and internally developed assets face additional research-versus-development hurdles.</p>

<h3>First Principles Thinking: Observable Cost vs. Uncertain Creation</h3><p><strong>A is correct.</strong> Purchased intangibles have a clear, observable transaction price—making measurement straightforward—so capitalization is required. Internally developed assets do not have this external verification; early expenditures are uncertain and exploratory. IFRS therefore forces expensing during the research phase and allows capitalization only after technical feasibility and intent to complete are demonstrated in the development phase. This distinction ensures that only expenditures tied to a demonstrably valuable asset become capitalized.</p><p>B is incorrect because sale to external customers is irrelevant to recognition; capitalization depends on control and future benefits, not external sales.</p><p>C is incorrect because research costs must be expensed. Capitalization begins only once the project enters the development phase and meets feasibility criteria.</p>

<h3>First Principles Thinking: Feasibility as the Capitalization Threshold</h3><p><strong>B is correct.</strong> IFRS uses feasibility as the dividing line because capitalization requires that expenditures are tied to a resource capable of generating predictable future benefits. During research, outcomes are unknown, so expensing is required. Once feasibility and intent to complete are demonstrated, the expenditures contribute directly to constructing a future economic resource and can be capitalized. This reflects the core principle: capitalize only when value creation is sufficiently certain.</p><p>A is incorrect because research expenditures are inherently uncertain, exploratory, and lack evidence of future benefits.</p><p>C is incorrect because post-deployment maintenance preserves, not enhances, asset value and thus must be expensed as incurred.</p>

<h3>First Principles Thinking: GAAP's Feasibility Gate</h3><p><strong>B is correct.</strong> US GAAP mirrors an economic reasoning threshold: capitalization begins only when a project’s success becomes reasonably assured. Technological feasibility acts as this gate. Before feasibility, expenditures are exploratory and uncertain; after feasibility, the firm is constructing an asset with expected future utility. Thus, GAAP capitalizes costs incurred after feasibility but before the software is ready for use.</p><p>A is incorrect because capitalization does not wait until completion; it begins after feasibility and continues through development.</p><p>C is incorrect because preliminary design and feasibility studies occur before technological feasibility is established and must be expensed as incurred.</p>

<h3>First Principles Thinking: Residual Value After Identifiable Assets</h3><p><strong>B is correct.</strong> Goodwill is a residual—representing synergies, assembled workforce, customer relationships, and other benefits that cannot be individually identified or valued. Under the acquisition method, the acquirer first allocates the purchase price to identifiable assets and liabilities at fair value. Any excess of the purchase price over this identifiable net asset value reflects unidentifiable economic advantages and is recorded as goodwill. This follows the economic principle that goodwill is not valued directly; it emerges after all identifiable components are measured.</p><p>A is incorrect because this situation would imply a bargain purchase, not goodwill.</p><p>C is incorrect because goodwill is unrelated to the relative sizes of intangible versus tangible assets; it depends on the residual after all identifiable assets and liabilities are measured.</p>

<h3>First Principles Thinking: Fair-Value Prioritization</h3><p><strong>B is correct.</strong> IFRS requires identifying and measuring all identifiable assets and liabilities at fair value because these are the components that can be independently measured and controlled. Only after allocating the purchase price to these identifiable components is the residual—representing unidentifiable economic benefits—recorded as goodwill. This ordering ensures that goodwill is not overstated and reflects only the portion of value that cannot be attributed to separable assets.</p><p>A is incorrect because equal allocation ignores economic reality and violates fair-value measurement principles.</p><p>C is incorrect because goodwill is a residual; it cannot be measured before identifiable assets.</p>

<h3>First Principles Thinking: Economic Life vs. Legal Life</h3><p><strong>B is correct.</strong> An intangible has an indefinite life when future economic benefits are expected to continue without a predictable end point. The concept rests on economic substance: if there is no clear horizon at which benefits will cease, the asset cannot be amortized. Instead, it is tested for impairment annually. Legal life does not determine accounting life; economic usefulness does.</p><p>A is incorrect because management intent alone cannot override economic evidence; indefinite life is an economic, not subjective, assessment.</p><p>C is incorrect because legal life does not determine useful life. A brand may have a long legal term but still face declining economic benefits.</p>

<h3>First Principles Thinking: Scope of Accounting Assets</h3><p><strong>B is correct.</strong> An "economic" balance sheet includes a wide range of assets such as a company's **reputation and its trained, experienced workforce**. However, "accounting" balance sheets prepared under IFRS and US GAAP permit the recognition of a **narrow range of assets** that meet strict criteria, and internally generated human capital does not meet the recognition criteria of reliable measurement or control over resources arising from past events.</p><p>A is incorrect: Property, plant, and equipment are routinely recognized on the accounting balance sheet.</p><p>C is incorrect: An **acquired** brand name is an identifiable intangible asset that is recognized on the accounting balance sheet at its fair value under the acquisition method.</p>

<h3>First Principles Thinking: Measurement Models for Long-Lived Assets</h3><p><strong>B is correct.</strong> Once a long-lived asset is recognized, IFRS permits a choice between the **cost or revaluation models** for subsequent measurement. In contrast, **US GAAP requires the cost model** for the subsequent measurement of PPE, which is one of the key differences for analysts comparing companies using the two GAAPs.</p><p>A is incorrect: This statement reverses the actual requirements; IFRS permits *both* models, and US GAAP requires the *cost* model.</p><p>C is incorrect: US GAAP does not permit the revaluation model for PPE held for use.</p>

<h3>First Principles Thinking: IFRS R&D Expense Requirement</h3><p><strong>B is correct.</strong> IFRS requires expensing **research costs** because this phase is considered too uncertain to meet the capitalization criteria. In contrast, IFRS allows **development costs** to be capitalized under certain conditions, such as the demonstration of technical feasibility and the intent to use or sell the asset.</p><p>A is incorrect: This is the treatment for the *development* phase if all criteria are met, not the research phase.</p><p>C is incorrect: Establishing feasibility is a condition for capitalizing the **development** phase costs.</p>

<h3>First Principles Thinking: US GAAP R&D Expense Rule</h3><p><strong>B is correct.</strong> Generally, **US GAAP requires that both research and development costs be expensed** as they are incurred. The rationale is that the future economic benefits of R&D are uncertain. An exception exists for certain development costs related to software, which must be capitalized after a defined point.</p><p>A is incorrect: This is contrary to the US GAAP general rule.</p><p>C is incorrect: This describes the general IFRS treatment, not the general US GAAP rule.</p>

<h3>First Principles Thinking: Acquisition Method and Goodwill</h3><p><strong>B is correct.</strong> Under the acquisition method, the acquirer allocates the purchase price to **each asset acquired and each liability assumed on the basis of its fair value**. Goodwill is then recorded as **any excess of the purchase price over the fair value of net identifiable assets acquired**.</p><p>A is incorrect: The allocation is based on **fair value** at the acquisition date, not the acquired company's historical carrying amounts.</p><p>C is incorrect: The allocation applies to *all* assets and liabilities, both tangible and intangible, not just the identifiable intangible assets.</p>

<h3>First Principles Thinking: Cost Allocation Terminology</h3><p><strong>A is correct.</strong> For **long-lived tangible assets** (PPE), the cost allocation process is called **depreciation**. For **intangible assets with finite useful lives**, the process is called **amortization**. Both serve to systematically allocate cost over the asset's useful life.</p><p>B is incorrect: Amortization is only for intangible assets.</p><p>C is incorrect: Impairment charges reflect an *unexpected decline* in value below the carrying amount, not the systematic allocation of cost.</p>

<h3>First Principles Thinking: Impairment Testing</h3><p><strong>C is correct.</strong> **Intangible assets with an indefinite useful life are not amortized**. They are instead reviewed for impairment **annually** because there is no systematic cost allocation. Long-lived tangible assets and intangible assets with finite useful lives are reviewed for impairment only when changes in events or circumstances indicate that the carrying amount may not be recoverable (a triggering event).</p><p>A is incorrect: These assets are **amortized** and reviewed for impairment only upon a triggering event.</p><p>B is incorrect: These assets are **depreciated** and reviewed for impairment only upon a triggering event.</p>

<h3>First Principles Thinking: Impairment Reversal Policy</h3><p><strong>B is correct.</strong> **IFRS permit impairment losses to be reversed**, with the reversal reported as a **gain in profit**. This contrasts directly with **US GAAP, which do not permit the reversal of impairment losses** on long-lived assets held for use.</p><p>A is incorrect: US GAAP does not permit the reversal of impairment losses.</p><p>C is incorrect: IFRS permits the reversal of impairment losses.</p>

<h3>First Principles Thinking: Cash Flow Classification of Intangibles</h3><p><strong>A is correct.</strong> Although capitalized on the balance sheet, the costs of **internally developing intangible assets** are generally classified as **operating cash outflows**. Conversely, the costs of **acquiring intangible assets** in an external purchase are classified as **investing cash outflows**. This difference in cash flow classification impacts analytical ratios, despite similar balance sheet treatment (capitalization).</p><p>B is incorrect: Investing cash outflows are typically for externally acquired intangible assets.</p><p>C is incorrect: Financing cash outflows relate to debt and equity transactions.</p>

<h3>First Principles Thinking: IFRS Intangible Asset Criteria</h3><p><strong>B is correct.</strong> Under IFRS, the three **definitional criteria** are: (1) **identifiable** (either capable of being separated from the entity or arising from contractual or legal rights), (2) under the **control** of the company, and (3) expected to generate future **economic benefits**. Separability is one way to meet the identifiability criterion.</p><p>A is incorrect: Reliable measurement is a **recognition** criterion.</p><p>C is incorrect: Probable flow of economic benefits is also a **recognition** criterion.</p>

<h3>First Principles Thinking: US GAAP Internal-Use Software Capitalization</h3><p><strong>C is correct.</strong> For software developed **for internal use**, US GAAP requires costs to be expensed until it is **probable that the project will be completed and that the software will be used as intended**. Thereafter, development costs are capitalized. This 'probability of completion' trigger is considered easier to demonstrate than technological feasibility.</p><p>A is incorrect: This is the general starting point for the development phase, but not the specific US GAAP capitalization trigger.</p><p>B is incorrect: Technological feasibility is the capitalization trigger for software developed **for sale**, not for internal use.</p>

<h3>First Principles Thinking: US GAAP Intangible Recognition in Acquisition</h3><p><strong>B is correct.</strong> Under US GAAP, an intangible asset acquired in a business combination is recognized separately from goodwill if it meets the criteria of being an item that can be **separated** from the acquired company or an item arising from **contractual or legal rights**. If it fails both criteria, its value is included in goodwill.</p><p>A is incorrect: The asset can have an indefinite useful life and still be recognized separately (e.g., an acquired brand).</p><p>C is incorrect: Assets acquired in a business combination are recorded at their **fair value** under the acquisition method.</p>

<h3>First Principles Thinking: Analytical Challenges from Policy Choices</h3><p><strong>B is correct.</strong> The **choice of different methods and varying accounting policies for long-lived assets** can create significant challenges for analysts. Under IFRS, the choice between the **cost model and the revaluation model** directly affects the carrying value of assets and the reported depreciation expense, necessitating adjustments for a meaningful comparison.</p><p>A is incorrect: Depreciation and amortization are simply the correct systematic allocation terms for tangible and intangible assets, respectively, and are not a source of inconsistency requiring adjustment between companies.</p><p>C is incorrect: Goodwill is a residual amount only recognized in an acquisition. Whether a company reports goodwill simply depends on whether they have made a business acquisition. The subsequent accounting for the goodwill itself (annual impairment review) is mandatory for both.</p>

<h3>First Principles Thinking: Definition of Impairment</h3><p><strong>B is correct.</strong> In contrast with depreciation and amortization, **impairment charges reflect an unexpected decline in the asset's fair value to an amount lower than its carrying amount**. They are recognized immediately to reflect the economic loss when the asset's book value is determined to be unrecoverable.</p><p>A is incorrect: This is the definition of depreciation/amortization.</p><p>C is incorrect: While indefinite-lived assets are reviewed for impairment annually, the impairment charge itself is only recorded if the asset is actually impaired, and it is a non-cash charge reflecting a loss, not a standard annual expense like amortization.</p>