CFA Practice Question

CFA Practice Question

Which of the following is (are) FALSE under U.S. GAAP?

I. Interest expenses that are capitalized are charged against investing cash flows.
II. Firms that expense interest costs incurred on debt must treat them as financing cash flows.
III. Firms that expense costs show lower equity than comparable firms that capitalize the costs.
IV. Capitalization of expenses leads to lower tax payments in the first year.
A. II and IV.
B. I and II.
C. I and III.
Explanation: Interest expenses are treated as operating cash flows under U.S. GAAP. Capitalization leads to higher net income since the entire expenses are not charged against it. Due to this, the tax deductions are lower in the first year, leading to higher taxes. The higher income leads to the capitalizing firm having a higher equity. The difference in equity reduces over time to zero.

User Contributed Comments 5

User Comment
KD101 Look at the first line of the reponse Interest Expense are treated as operating cash flows under US GAAP so answer (1) must be false
Alastair capitalised interest are treated as investing cash flows
avgas Isnt tax deduction the same as tax payment?low tax amount deducted =low tax paid? Please help.
julescruis false ..... grrrrrrrrrrrrrrr
tommyguard3 I'm not sure whether alastair is right or not, if they are then this explanation needs to be improved because the first line says that 1 is false.

Avgas, tax deduction is a deduction from income which means the higher the tax deduction the lower the tax paid and vice versa.

For example Client earns $10,000 and has $1,000 interest expense and 20% tax rate.

$10,000 - $1,000 = $9,000 x 20% = $1,800 tax paid

Same client only has $500 interest expense

$10,000 - $500 = $9,500 x 20% = $1,900 tax paid.

So as you can see higher deduction = lower tax paid/lower deduction = higher tax paid
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