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7-1Chapter7SolutionsOverview:ProblemLengthProblem#s{S}2,3,5,8,and10{M}1,4,6,7,9,11,12,and13Appendices{M}7A-1and7B-1{L}7A-2and7B-21.{M}Exhibit7S-1containsthecalculationsrequired.Exhibit7S-1.ChevronAdjustmentsforCapitalizationofInterestAmountsin$millionspartcYear199519961997199819991999/95AsreportedInterestexpense$401$364$312$405$4721.18Pretaxincome1,7894,7405,5021,8343,6482.04Netincome9302,6073,2561,3392,0702.23Capitalizedinterest141108823959Amortizationofcapitalizedinterest472428359a.CalculationsEBIT$2,190$5,104$5,814$2,239$4,120Timesinterestearned5.4614.0218.635.538.731.60b.AdjustedNetcapitalizedinterest$94$84$54$4$50After35%incometax615535333Interestexpense5424723944445310.98EBIT2,2375,1285,8422,2744,129(i)Timesinterestearned4.1310.8614.835.127.781.88(ii)%reductionfromreportedratio-24.4%-22.5%-20.4%-7.4%-10.9%Pretaxincome$1,695$4,656$5,448$1,830$3,5982.12(iii)Netincome8692,5523,2211,3362,0382.34%reductionfromreported-6.6%-2.1%-1.1%-0.2%-1.6%7-2b.(iv)Expensingallinterestreducesnetincomeforeachyear.Howevertheeffectdiminishesovertime.c.(i)Becausetheamountofinterestcapitalizeddeclinedovertime,restatementreducestherateofincreaseininterestexpense.(ii)Whiletheinterestcoverageratioislowerafterrestatement,itstrendimprovesduetothelowergrowthrateofinterestexpense.(iii)Bothpretaxandnetincomearelowerafterrestatementbuttheirgrowthrateimprovesduetothelowergrowthrateofinterestexpense.d.Therestateddataaremoreusefulforfinancialanalysisbecausetheyarebasedonactualinterestexpense.Theyprovidebettercomparabilitywithfirmsthatdonotcapitalizeinterest.2.{S}a.(i)Interestcostcanbecapitalizedonborrowingsdirectlyassociatedwiththeprojectorwhenthecompanyhasdebtequaltoorexceedingthecostofconstruction.(ii)Start-upcostsmustbeexpensedunderU.S.GAAP.(iii)Shippingcostsareconsideredpartofthecostofacquisition.(iv)IncreasesinthemarketvalueoflandandbuildingsmaynotberecognizedunderU.S.GAAP.b.(i)WhilethebenchmarktreatmentunderIAS23istoexpenseallinterest,capitalizationofborrowingcostsdirectlyattributabletoaprojectisanallowedalternative.(ii)SameasU.S.GAAPexceptthatthebenchmarkThecapitalizationofinterestisanallowedalternativeunderIAS23(paragraph11)(iii)SameasU.S.GAAP.(iv)WhilerevaluationisanallowedalternativeunderIAS16,itmustbeappliedtoallassetsinaparticularclassandcouldbeselectivelyappliedtoaparticularproject.3.{S}a.UnderSFAS86(textpage242),computersoftwaredevelopmentcostscanbecapitalizedonlywheneconomicfeasibilityhasbeenestablished.b.UnderIAS38(paragraph45),intangibleassetssuchascomputersoftwarecanberecognizedwhentheenterprisecandemonstratetechnicalandeconomicfeasibility.7-34.{M}Exhibit7S-2containsthecalculationsrequiredbypartsathroughc.Exhibit7S-2EricssonAmountsinSEKmillions199719981999a.UnderSwedishGAAP:Netsales167,740184,438215,403Pretaxincome17,21818,21016,386Totalassets147,440167,456202,628Stockholders'equity52,62463,11269,176Averagetotalassets157,448185,042Averagestockholders’equity57,86866,144Assetturnover1.171.16PretaxROE0.310.25b.Adjustments:Developmentcostsforsoftwaretobesold:Capitalization5,2327,1707,898Amortization(3,934)(3,824)(4,460)Writedown(989)Neteffect1,2983,3462,449Developmentcostsforsoftwareforinternaluse:Capitalization1,463Amortization(152)Neteffect--1,311Totalpretaxeffect1,2983,3463,760Adjustedpretaxincome18,51621,55620,146(i)%change8%18%23%7-4Exhibit7S-2(continued)Year-endbalances:Softwaretobesold7,39810,74413,193Internalusesoftware1,311Total7,39810,74414,504Less:deferredtax@35%(2,589)(3,760)(5,076)Increaseinequity4,8096,9849,428Adjustedtotalassets154,838178,200217,132(ii)%change5.0%6.4%7.2%Adjustedequity57,43370,09678,604(iii)%change9.1%11.1%13.6%c:Adjustedaverageassets166,519197,666Adjustedaverageequity63,76474,350(i)Adjustedassetturnover1.111.09(ii)AdjustedpretaxROE0.340.27d.TheadjustmentsforEricssonshowthatcapitalizationofsoftwaredevelopmentcostscanhaveasignificanteffectonreportedincomeandequity,andonfinancialratios.Thereforecomparabilityrequiresthatallfirmsberestatedtothesamebasis.e.Theamountscapitalizedhighlightexpendituresandenabletheanalysttoinquireaboutthenewproductsunderdevelopment.Theamortizationperiodusedmaybeusefulasaforecastoftheusefullifeoftheproduct.Inbothcases(capitalizationandamortization)significantchangesfrompriorperiodsmayprovideusefulsignalsofimpendingchange.7-55.{S}a.Thecapitalizationoftheinvestmentindisplaysdelaystheirimpactonincomeascomparedwithexpensing.Inaddition,cashfromoperationsispermanentlyincreasedastheexpendituresareclassifiedascashflowsforinvestment.Finally,iftheseexpendituresarevolatile,capitalizationandamortizationsmoothestheimpactonreportedincome.b.(i)In2000,thecapitalizedamountincreasedby$1,648,000.Hadpromotionaldisplaysbeenexpensed,netincomewouldbe$1,071,200(after35%tax)lower.Expensingwouldhavereducednetincomeby7.4%($1,071.2/$14,467).(ii)Shareholders’equitywouldbereducedby65%of$10,099,000equalto$6,564,350or7.1%.(iii)Reportedreturnon(average)assetsequals$14,467/[($166,656+$140,609)/2]=9.42%Adjustedreturnon(average)assetsequals($14,467–$1,071)/[($166,656-$10,099)+($140,609-$8,451)/2]=9.28%asa