MCQ Quiz

<h3>First Principles Thinking: Scope of Accounting Assets</h3><p><strong>B is correct.</strong> Accounting balance sheets, under both IFRS and US GAAP, adhere to strict criteria for asset recognition, which is a **narrow range of assets**. This typically requires the asset to be the result of a past transaction or event and have a cost or value that can be reliably measured. A company's **trained, experienced workforce** and **reputation** are examples of assets that generate **economic benefits** but are generally excluded from the 'accounting' balance sheet because they are not reliably measurable or do not meet the definition of a control over resources arising from past events.</p><p>A is incorrect: Assets acquired in a business combination are recognized at their **fair value** using the acquisition method, including tangible assets like buildings.</p><p>C is incorrect: **Property, plant, and equipment** (tangible assets) are routinely recognized on the balance sheet, as they are employed to generate economic benefits for many years, and their cost is reliably measurable.</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 two models for subsequent measurement: the **cost** or **revaluation models**. In contrast, **US GAAP requires the cost model** for the subsequent measurement of PPE, generally prohibiting the use of the revaluation model. This difference in method choice can create challenges for analysts comparing companies.</p><p>A is incorrect: This reverses the requirements; IFRS permits *both*, and US GAAP requires the *cost* model.</p><p>C is incorrect: IFRS permits revaluation but does not *require* annual revaluation; it allows the cost model. US GAAP does not generally permit the revaluation model after initial recognition.</p>

<h3>First Principles Thinking: R&D Cost Treatment (IFRS vs. US GAAP)</h3><p><strong>B is correct.</strong> IFRS requires expensing **research costs**. However, IFRS allows **development costs** (not only software development costs) to be **capitalized under certain conditions**. Generally, **US GAAP requires that both research and development costs be expensed**, with an exception for certain software development costs. Therefore, IFRS has broader criteria that would more likely permit the capitalization of the development phase costs.</p><p>A is incorrect: IFRS requires expensing research costs, so it does not permit capitalization of both.</p><p>C is incorrect: IFRS requires expensing research costs, and it allows development costs to be capitalized under certain conditions.</p>

<h3>First Principles Thinking: Calculation of Goodwill</h3><p><strong>A is correct.</strong> The acquisition method of accounting requires the acquirer to allocate the purchase price to each asset acquired and liability assumed based on its fair value. Goodwill is defined as **any excess of the purchase price over the fair value of net identifiable assets acquired**. The calculation is: Goodwill = Purchase Price $-$ Fair Value of Net Identifiable Assets. Applying the numbers: Goodwill = $500 million $-$ $420 million = **$80 million**.</p><p>B is incorrect: $420 million is the fair value of the net identifiable assets, not the goodwill.</p><p>C is incorrect: $500 million is the total purchase price, which is allocated between the net identifiable assets and goodwill.</p>

<h3>First Principles Thinking: Cost Allocation Terminology</h3><p><strong>A is correct.</strong> The capitalized costs of long-lived tangible assets and of intangible assets with finite useful lives are allocated to expense in subsequent periods over their useful lives. For **long-lived tangible assets**, this process is referred to as **depreciation**. For **intangible assets** with finite useful lives, it is referred to as **amortization**.</p><p>B is incorrect: This confuses the standard terminology. Depreciation is for tangibles; amortization is for intangibles.</p><p>C is incorrect: **Impairment charges** reflect an **unexpected decline** in fair value below the carrying amount, not the systematic allocation of cost over the asset's useful life.</p>

<h3>First Principles Thinking: Impairment Triggers</h3><p><strong>B is correct.</strong> Long-lived tangible assets and intangible assets with finite useful lives are reviewed for impairment **whenever changes in events or circumstances indicate that the carrying amount of an asset may not be recoverable**. This is the 'triggering event' approach.</p><p>A is incorrect: **Intangible assets with an indefinite useful life** (like goodwill) are reviewed for impairment **annually**. Tangible assets use the 'triggering event' approach.</p><p>C is incorrect: The trigger is the *indication* that the carrying amount *may not* be recoverable. The formal test that compares the fair value to the carrying amount is the second step of the review process, conducted *after* the trigger is identified.</p>

<h3>First Principles Thinking: Impairment Reversal Policy</h3><p><strong>A is correct.</strong> IFRS provides more flexibility in accounting for impairment losses. Under IFRS, impairment losses are **permitted to be reversed**, with the reversal reported in **profit**. In direct contrast, **US GAAP do not permit the reversal of impairment losses** on long-lived assets held for use.</p><p>B is incorrect: US GAAP does not permit the reversal of impairment losses. The reporting of the reversal under IFRS is generally in profit.</p><p>C is incorrect: US GAAP does not permit the reversal of impairment losses.</p>

<h3>First Principles Thinking: Gain/Loss on Sale Formula</h3><p><strong>A is correct.</strong> The gain or loss on the sale of long-lived assets is computed as the **sale proceeds minus the carrying amount** (or book value) of the asset at the time of sale. First, calculate the carrying amount (CA): $120,000 (Cost) $-$ $60,000 (Accumulated Depreciation) = $60,000 (CA). Next, calculate the gain/loss: Gain/Loss = Sale Proceeds $-$ Carrying Amount = $75,000 $-$ $60,000 = **$15,000 Gain**. Since the proceeds ($75,000) exceed the CA ($60,000), a gain is recognized.</p><p>B is incorrect: This calculation would result from subtracting the sale proceeds from the carrying amount ($60,000 $-$ $75,000 = -$15,000 loss). The asset was sold for more than its book value.</p><p>C is incorrect: $60,000 is the accumulated depreciation and also the carrying amount in this specific example. The gain is the difference between proceeds and CA.</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 challenges for analysts comparing companies**. Even under the same GAAP (IFRS or US GAAP), companies have choices, such as selecting different useful lives or depreciation methods (e.g., straight-line vs. double-declining balance). These choices directly impact reported net income, assets, and cash flow from operations, necessitating adjustments by the analyst for an 'apples-to-apples' comparison.</p><p>A is incorrect: While using different GAAPs (IFRS vs. US GAAP) is a major challenge (e.g., R&D expensing, impairment reversal), the text specifically highlights that the choice of different methods for long-lived assets within the standards creates challenges.</p><p>C is incorrect: If both companies use the same GAAP and the same accounting policies, the challenge for comparison is minimized.</p>

<h3>First Principles Thinking: Definition of Impairment</h3><p><strong>B is correct.</strong> In contrast with depreciation and amortization charges, **impairment charges reflect an unexpected decline in the fair value of an asset to an amount lower than its carrying amount**. They are non-cash charges that immediately recognize an economic loss when an asset's book value is determined to be unrecoverable.</p><p>A is incorrect: This is the definition of **depreciation** (for tangible assets) or **amortization** (for intangible assets), which serve to **allocate the cost** over the useful life, contrasting with impairment.</p><p>C is incorrect: If an asset is sold for less than its carrying amount, a **loss on sale** is recognized. Impairment is recorded while the asset is *still held*.</p>

<h3>First Principles Thinking: Amortization and Indefinite Life Intangibles</h3><p><strong>B is correct.</strong> **Intangible assets with an indefinite useful life are not amortized**. Since their economic benefits are expected to continue indefinitely, there is no finite period over which to systematically allocate their cost. Instead of amortization, they are **reviewed for impairment annually**.</p><p>A is incorrect: Intangible assets with a **finite useful life** *are* amortized and reviewed for impairment upon a triggering event.</p><p>C is incorrect: Intangible assets acquired in a business combination are classified as either finite- or indefinite-lived, and their accounting follows the rules for that classification.</p>

<h3>First Principles Thinking: IFRS R&D Expense Requirement</h3><p><strong>B is correct.</strong> IFRS distinguishes between research and development. IFRS **requires expensing research costs**. The research phase is too uncertain to meet the capitalization criteria. Once the phase is identified as **development**, IFRS allows capitalization **under certain conditions**.</p><p>A is incorrect: IFRS allows **development costs** to be **capitalized** under certain conditions, such as technical and commercial feasibility being established.</p><p>C is incorrect: IFRS allows development costs, which includes software development, to be capitalized if conditions are met.</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. This is based on the principle that the future benefits of R&D expenditures are uncertain and difficult to measure reliably. While there is an exception for certain **development costs related to software** that must be capitalized, the general rule for R&D is immediate expensing.</p><p>A is incorrect: IFRS allows for the capitalization of development costs, but US GAAP generally requires expensing both.</p><p>C is incorrect: This describes the general IFRS treatment (research expensed, development potentially capitalized), not the general US GAAP rule.</p>

<h3>First Principles Thinking: Acquisition Method Mechanics</h3><p><strong>B is correct.</strong> Under the acquisition method, the company identified as the acquirer allocates the purchase price to **each asset acquired (and each liability assumed) on the basis of its fair value**. Only after this step is complete, **any excess of the purchase price over the fair value of net identifiable assets acquired is recorded as goodwill**.</p><p>A is incorrect: Goodwill is a **residual** value, not the primary allocation target. It is the excess remaining *after* allocation to identifiable assets/liabilities at fair value.</p><p>C is incorrect: The allocation is based on **fair value** at the acquisition date, not the acquired company's pre-acquisition **carrying amounts**.</p>

<h3>First Principles Thinking: The Purpose of Amortization vs. Impairment</h3><p><strong>A is correct.</strong> **Amortization** (and depreciation) serves to **allocate the cost of a long-lived asset over its useful life**. It is a systematic, expected charge. In contrast, **impairment charges reflect an unexpected decline in the fair value of an asset to an amount lower than its carrying amount**. The loss is recorded when the asset is deemed unrecoverable.</p><p>B is incorrect: Amortization applies to intangible assets. Depreciation applies to tangible assets. Impairment applies to *both* tangible and intangible long-lived assets.</p><p>C is incorrect: IFRS **permit impairment losses to be reversed**. US GAAP does not permit the reversal.</p>

<h3>First Principles Thinking: US GAAP Software Development Exception</h3><p><strong>C is correct.</strong> The general US GAAP rule is that both research and development costs must be expensed. However, the guidance explicitly notes an exception: **certain development costs related to software must be capitalized**. This mandatory capitalization rule for specific software development costs (once technological feasibility is established) is a key point of difference and an exception to the general US GAAP expensing rule.</p><p>A is incorrect: The general rule is to expense R&D, but the software development exception exists.</p><p>B is incorrect: While IFRS *allows* development costs to be capitalized under conditions, the US GAAP exception *requires* capitalization for certain software costs.</p>

<h3>First Principles Thinking: Indefinite Life Intangibles Accounting</h3><p><strong>B is correct.</strong> **Intangible assets with an indefinite useful life are not amortized**. Since their economic benefits are expected to continue indefinitely, there is no finite period over which to systematically allocate their cost. Instead of amortization, they are **reviewed for impairment annually**.</p><p>A is incorrect: Only assets with a **finite useful life** are amortized.</p><p>C is incorrect: Intangible assets with an indefinite useful life are reviewed for impairment **annually**. The review upon a triggering event applies to finite-lived tangible and intangible assets.</p>

<h3>First Principles Thinking: Scope of Assets on Balance Sheets</h3><p><strong>B is correct.</strong> An **"economic" balance sheet** would include a **wide range of assets** such as a company's reputation and its trained, experienced workforce. These items generate economic benefits but are often internally generated and hard to measure reliably. In contrast, the **"accounting" balance sheet** prepared under IFRS and US GAAP permits the recognition of a **narrow range of assets** that meet specific recognition criteria (e.g., control, measurable cost).</p><p>A is incorrect: The accounting balance sheet includes both tangible (PPE) and recognized intangible assets. The economic balance sheet is broader than just tangibles.</p><p>C is incorrect: The accounting balance sheet can use historical cost (cost model) or, in some cases, fair value (IFRS revaluation model). The economic balance sheet's core distinction is its broader *scope* of recognized value.</p>

<h3>First Principles Thinking: Effect of Measurement Model on Financial Statements</h3><p><strong>B is correct.</strong> The choice between the cost model and the revaluation model impacts both the balance sheet and the income statement. The **carrying value of the assets** on the balance sheet differs because the revaluation model uses fair value, while the cost model uses historical cost. Furthermore, **depreciation expense** is calculated based on this carrying value (or revalued amount), directly affecting the income statement. This **choice of different methods** creates challenges for analysts, often necessitating adjustments to achieve comparability.</p><p>A is incorrect: This choice is an operational/reporting decision and does not directly affect cash flow from financing activities.</p><p>C is incorrect: Goodwill is only recognized during a **business combination**. The subsequent measurement model for assets already held does not impact a past goodwill calculation.</p>

<h3>First Principles Thinking: IFRS Impairment Reversal Reporting</h3><p><strong>C is correct.</strong> IFRS **permit impairment losses to be reversed** (up to the carrying amount the asset would have had if no impairment loss was recognized). When an impairment loss is reversed, the reversal is reported as a **gain in profit** (i.e., on the income statement). This increase in profit restores the value previously recognized as a loss, impacting the current period's earnings.</p><p>A is incorrect: Increases from the **revaluation model** are typically reported in OCI, but impairment reversals are generally reported in profit.</p><p>B is incorrect: Impairment reversals relate to assets, not liabilities, and result in an increase in profit (a gain).</p>

<h3>First Principles Thinking: Asset Classification and Cost Allocation</h3><p><strong>A is correct.</strong> Aircraft are **long-lived tangible assets** (Property, Plant, and Equipment), and the allocation of their cost over their useful life is referred to as **depreciation**. The capitalized brand name, with an **indefinite useful life**, is an **intangible asset** that is **not amortized**. Instead, it is reviewed for impairment annually, meaning there is no periodic, systematic expense (cost allocation).</p><p>B is incorrect: Amortization is for intangibles. The indefinite life of the brand name means it is not amortized.</p><p>C is incorrect: The aircraft is a tangible asset and is depreciated. While the brand name is subject to impairment, impairment is an unexpected charge, not a systematic, periodic cost allocation like amortization or depreciation.</p>