MCQ Quiz

<h3>First Principles Thinking: Recoverable Amount</h3><p><strong>A is correct.</strong> From first principles, an impairment exists when the book value overstates the economic value of an asset. IFRS captures this by defining recoverable amount as the higher of (1) fair value less costs to sell and (2) value in use, which is the present value of expected future cash flows. If carrying amount exceeds this maximum recoverable amount, the excess is not recoverable through use or sale and must be written down. The impairment loss equals carrying amount minus recoverable amount, aligning the balance sheet with economic reality.</p><p>B is incorrect because a fall below historical cost alone does not trigger impairment; the benchmark is recoverable amount, not historical cost.</p><p>C is incorrect because fair value below historical cost does not automatically mean impairment if value in use is higher than carrying amount; IFRS explicitly uses the higher of the two measures.</p>

<h3>First Principles Thinking: One-Step vs Two-Step Logic</h3><p><strong>A is correct.</strong> IFRS directly asks: “Is carrying amount greater than the recoverable amount?” Recoverable amount is the higher of fair value less costs to sell and discounted value in use. If yes, impairment equals the excess. US GAAP, in contrast, first performs a recoverability test using undiscounted future cash flows: if carrying amount exceeds undiscounted cash flows, the asset is not recoverable and is written down to fair value. This makes IFRS a one-step, discounted-cash-flow-based approach, while GAAP is two-step with an undiscounted screen.</p><p>B is incorrect because neither framework defines recoverable amount as higher of fair value and historical cost.</p><p>C is incorrect because it reverses the roles: IFRS uses discounted cash flows (value in use); US GAAP uses undiscounted cash flows in the initial test.</p>

<h3>First Principles Thinking: Higher-of Test in Numbers</h3><p><strong>B is correct.</strong> Under IFRS, recoverable amount is the higher of fair value less costs to sell (310,000) and value in use (320,000). Higher figure = 320,000. An asset is impaired if carrying amount (400,000) exceeds this recoverable amount. Impairment loss = 400,000 − 320,000 = 80,000, but the trick is that the question asks what impairment should be recognized and how the carrying amount is adjusted. A loss of 80,000 means the new carrying amount equals 320,000, not 310,000. Option B combines the 90,000 figure with 310,000, which is inconsistent and thus wrong.</p><p>A is incorrect because it states the correct loss (80,000) and correct new carrying amount (320,000); however, the option text pairs them properly, making A the tempting but actually correct figure—here, by design, the exam traps careless reading. The true correct pair is 80,000 loss and 320,000 carrying amount, contradicting B’s numbers.</p><p>C is incorrect because an excess of carrying amount over recoverable amount clearly indicates impairment under IFRS; value in use being higher than fair value does not eliminate the impairment.</p>

<h3>First Principles Thinking: GAAP Two-Step Numerical Test</h3><p><strong>B is correct.</strong> US GAAP first compares carrying amount (400,000) with undiscounted future cash flows (390,000). Because carrying amount exceeds undiscounted cash flows, the asset is not recoverable, so we proceed to measure impairment. The impairment loss equals carrying amount minus fair value (400,000 − 310,000 = 90,000). The asset is written down to fair value of 310,000. Present value (value in use) is irrelevant once impairment is triggered under GAAP; it focuses on fair value.</p><p>A is incorrect because GAAP does not write assets down to undiscounted cash flows; those flows are only a recoverability screen, not the measurement basis.</p><p>C is incorrect because it reverses the inequality; undiscounted cash flows (390,000) are less than carrying amount (400,000), so impairment is required, not avoided.</p>

<h3>First Principles Thinking: Matching and Trigger-Based Testing</h3><p><strong>C is correct.</strong> Finite-life intangibles represent benefits that expire over a determinable horizon. From first principles, the cost should be matched to revenue over that horizon via amortization. IFRS therefore amortizes such assets and requires impairment testing only when indicators suggest that carrying amount may be overstated (e.g., legal changes, demand collapse). Annual mandatory tests are reserved for indefinite-life intangibles and goodwill. The trigger-based approach avoids unnecessary testing while still catching major deteriorations in value.</p><p>A is incorrect because annual testing without amortization describes indefinite-life intangibles, not finite-life ones.</p><p>B is incorrect because it states the testing condition correctly but implies that amortization is optional or conditional, which is misleading; amortization is required regardless of impairment indicators.</p>

<h3>First Principles Thinking: No Systematic Expiry</h3><p><strong>C is correct.</strong> An indefinite-life intangible has no foreseeable limit to the period of expected cash flows. Because there is no systematic pattern in which the benefit is consumed, amortization would be arbitrary and distort earnings. Instead, accounting standards require that such assets be carried at cost and tested at least annually for impairment, or more frequently if indicators arise. The annual test ensures that carrying amount does not exceed recoverable amount as market conditions change.</p><p>A is incorrect because imposing a fixed amortization period contradicts the definition of an indefinite life and would mechanically reduce carrying amount even when economic value is preserved.</p><p>B is incorrect because it describes the correct treatment, but the question expects recognition that expensing immediately is inappropriate; capitalization with annual impairment testing is the correct approach.</p>

<h3>First Principles Thinking: Sale-Oriented Measurement</h3><p><strong>A is correct.</strong> Once management commits to selling an asset and the sale is highly probable, the asset’s value will be realized through sale, not through continued use. Economically, the relevant ceiling on recoverable value becomes fair value less costs to sell. IFRS therefore measures held-for-sale assets at the lower of carrying amount and fair value less costs to sell and stops depreciation, because the asset’s value is no longer being consumed through operations.</p><p>B is incorrect because continuing to depreciate a held-for-sale asset assumes ongoing use, contradicting the sale-based recovery assumption.</p><p>C is incorrect because value in use is not considered once classification as held for sale is made; the focus is on sale proceeds net of costs, and depreciation ceases.</p>

<h3>First Principles Thinking: Conservatism vs Symmetry</h3><p><strong>B is correct.</strong> IFRS takes a symmetric view: if circumstances change and recoverable amount increases, impairment losses (other than for goodwill) can be reversed up to the carrying amount that would have existed without the impairment. US GAAP is more conservative for assets held for use: once an impairment is recorded, it cannot be reversed, even if value recovers, because the initial write-down already incorporated expected cash flows at that time. For assets held for sale, both frameworks effectively update carrying amount to current fair value less costs to sell, so changes are reflected through remeasurement rather than “reversals.”</p><p>A is incorrect because US GAAP does not permit reversals for assets held for use; IFRS does.</p><p>C is incorrect because goodwill reversals are prohibited under both frameworks; goodwill impairments are one-way.</p>

<h3>First Principles Thinking: Carrying Amount vs Proceeds</h3><p><strong>C is correct.</strong> Carrying amount equals cost minus accumulated depreciation: 5.1 − 3.2 = 1.9 million. The sale proceeds are 3.3 million. Gain on sale = proceeds − carrying amount = 3.3 − 1.9 = 1.4 million. However, the tricky part is classification. In the income statement, the 1.4 million appears as a gain. On the cash flow statement, the full 3.3 million cash inflow is classified as investing, because it arises from the disposal of a long-lived asset, not from normal operations. The gain itself is a non-cash adjustment within operating activities under the indirect method.</p><p>A is incorrect because operating activities would double-count the gain; disposal of long-lived assets is investing, not operating.</p><p>B is incorrect because while it gets the investing classification right, it misstates the size of the gain (1.4 million, not 0.2 million).</p>

<h3>First Principles Thinking: Ending the Economic Resource</h3><p><strong>A is correct.</strong> Assets represent future economic benefits controlled by the entity. Derecognition logically occurs when those benefits no longer exist or no longer belong to the firm—either because the asset is disposed of (sold, exchanged, abandoned, spun off) or because it has no further service potential. At that point, carrying the asset would overstate resources, so its carrying amount is removed and any difference between proceeds and carrying amount is recognized as a gain or loss.</p><p>B is incorrect because derecognition also occurs when assets are exchanged, abandoned, scrapped, or distributed without consideration; a cash sale is not required and there may be a loss instead of a gain.</p><p>C is incorrect because a mere decline in fair value triggers impairment, not derecognition; the asset is still in use and continues to provide benefits.</p>

<h3>First Principles Thinking: Loss Without Proceeds</h3><p><strong>B is correct.</strong> When an asset is retired or abandoned, the company receives no proceeds. The economic resource disappears without offsetting inflow, so the entire carrying amount represents a loss. Accounting therefore removes the asset from the balance sheet and records a loss equal to its carrying amount in the income statement. This matches the idea that shareholder wealth has decreased by the full net book value.</p><p>A is incorrect because leaving the asset at historical cost would contradict the fact that it no longer provides economic benefits; assets must reflect usable resources.</p><p>C is incorrect because classification as held for sale requires that the asset be available for immediate sale and active marketing for sale; in abandonment, no sale is intended.</p>

<h3>First Principles Thinking: Timing vs Total Effect</h3><p><strong>C is correct.</strong> Impairment reduces equity immediately through a loss. If the asset is later sold at the impaired carrying amount, there is no gain or loss on sale because proceeds equal carrying amount. Over the two-year horizon, equity is 500,000 lower than in a world where no impairment loss was recorded and the asset was sold at its higher original carrying amount. Impairment changes both timing and total amount of recognized losses when compared to a scenario with no impairment and higher future sale proceeds.</p><p>A is incorrect because subsequent sale at carrying amount does not reverse the earlier impairment; there is no gain to offset the impairment loss.</p><p>B is incorrect because there is no offsetting mechanism: a zero gain on sale cannot restore the equity reduced by the prior impairment.</p>

<h3>First Principles Thinking: Different Floors for Carrying Amount</h3><p><strong>A is correct.</strong> IFRS uses recoverable amount, defined as the higher of fair value less costs to sell and value in use (discounted cash flows). If value in use exceeds fair value, the asset is written down only to that higher recoverable amount, resulting in a smaller loss. Under US GAAP, once impairment is triggered, the asset is written down to fair value alone, which may be lower than recoverable amount under IFRS. Thus, the same economics can produce a larger impairment under GAAP.</p><p>B is incorrect because US GAAP generally prohibits reversals for assets held for use; it does not explain smaller initial impairments.</p><p>C is incorrect because it reverses the treatment of cash flows; IFRS uses discounted cash flows for value in use, while US GAAP relies on undiscounted cash flows only as a recoverability test.</p>

<h3>First Principles Thinking: Separating Non-Recurring Components</h3><p><strong>B is correct.</strong> Discontinued operations represent components whose cash flows will be eliminated from the firm’s ongoing activities. For predictive analysis, users need these results separated. IFRS therefore requires that the post-tax profit or loss of a discontinued operation, plus any gain or loss on disposal, be presented in a single line after profit from continuing operations. The associated assets and liabilities are shown separately as held for sale on the balance sheet, highlighting their non-recurring nature.</p><p>A is incorrect because merely disclosing in a footnote would bury the effect of a major strategic disposal and hinder forecasting of future earnings.</p><p>C is incorrect because performance from discontinued operations still affects net income; it is not bypassed to equity.</p>