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with respect to statement 1 which of the following is the most likely effect of mana 599833

Melanie Hart, CFA, is a transportation analyst. Hart has been asked to write a research report on Altai Mountain Rail Company (AMRC). Like other companies in the railroad industry, AMRC’s operations are capital intensive, with significant investments in such long-lived tangible assets as property, plant, and equipment. In November of 2008, AMRC’s board of directors hired a new team to manage the company. In reviewing the company’s 2009 annual report, Hart is concerned about some of the accounting choices that the new management has made. These choices differ from those of the previous management and from common industry practice. Hart has highlighted the following statements from the company’s annual report:

Statement 1:

“In 2009, AMRC spent significant amounts on track replacement and similar improvements. AMRC expensed rather than capitalized a significant proportion of these expenditures.”

Statement 2:

“AMRC uses the straight-line method of depreciation for both financial and tax reporting purposes to account for plant and equipment.”

Statement 3:

“In 2009, AMRC recognized an impairment loss of €50 million on a fleet of locomotives. The impairment loss was reported as ‘other income’ in the income statement and reduced the carrying amount of the assets on the balance sheet.”

Statement 4:

“AMRC acquires the use of many of its assets, including a large portion of its fleet of rail cars, under long-term lease contracts. In 2009, AMRC acquired the use of equipment with a fair value of €200 million under 20-year lease contracts. These leases were classified as operating leases. Prior to 2009, most of these lease contracts were classified as finance leases.”

Exhibits A and B contain AMRC’s 2009 consolidated income statement and balance sheet. AMRC prepares its financial statements in accordance with International Financial Reporting Standards.

EXHIBIT A Consolidated Statement of Income

For the Years Ended 31 December

2009

2008

E in millions

% Revenues

E in millions

% Revenues

Operating revenues

2,600

100.0%

2,300

100.0%

Operating expenses

Depreciation

(200)

(7.7%)

(190)

(8.3%)

Lease payments

(210)

(8.1%)

(195)

(8.5%)

Other operating expense

(1,590)

(61.1%)

(1,515)

(65.9%)

Total operating expenses

(2,000)

(76.9%)

(1,900)

(82.6%)

Operating income

600

23.1%

400

17.4%

Other income

(50)

(1.9%)

0.0%

Interest expense

(73)

(2.8%)

(69)

(3.0%)

Income before taxes

477

18.4%

331

14.4%

Income taxes

(189)

(7.3%)

(125)

(5.4%)

Net income

288

11.1%

206

9.0%

Consolidated Balance Sheet

As of 31 December

2009

2008

E in millions

% Assets

E in millions

% Assets

Assets

Current assets

500

9.4%

450

8.5%

Property & equipment:

Land

700

13.1%

700

13.2%

Plant & equipment

6,000

112.1%

5,800

109.4%

Total property & equipment

6,700

125.2%

6,500

122.6%

Accumulated depreciation

(1,850)

(34.6%)

(1,650)

(31.1%)

Net property & equipment

4,850

90.6%

4,850

91.5%

Total assets

5,350

100.0%

5,300

100.0%

liabilities and shareholders’ equity

Current liabilities

480

9.0%

430

8.1%

Long-term debt

1,030

19.3%

1,080

20.4%

Other long-term provisions and liabilities

1,240

23.1%

1,440

27.2%

Total liabilities

2,750

51.4%

2,950

55.7%

shareholders’ equity

Common stock and paid-in-surplus

760

14.2%

760

14.3%

Retained earnings

1,888

35.3%

1,600

30.2%

Other comprehensive losses

(48)

(0.9%)

(10)

(0.2%)

With respect to Statement 1, which of the following is the most likely effect of management’s decision to expense rather than capitalize these expenditures?

A. 2009 net profit margin is higher than if the expenditures had been capitalized.

B. 2009 total asset turnover is lower than if the expenditures had been capitalized.

C. Future profit growth will be higher than if the expenditures had been capitalized.

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