Tecktroniks Company reported in its annual report software refinement expenses of $12 million, $15 million, and $18 million for fiscal years 2005, 2006, and 2007, respectively. At the end of fiscal 2007, it had total assets of $140 million. Net income was $20 million for fiscal 2007, and it had a marginal tax rate of 35%.
-If software refinement had been capitalized each year and amortized over a three-year period beginning in the year the cost was incurred, net income for fiscal 2007 would have been:
A)$31.7 million.
B)$29.75 million.
C)$21.95 million.
D)$14.95 million.

Question

Quizplus · Accepted Answer

Capitalizing and amortizing the software refinement expenses over three years would change the expenses recognized each year. For 2005, $12 million would be spread over three years, so $4 million per year for 2005, 2006, and 2007. Similarly, for 2006, $15 million over three years would be $5 million per year for 2006 and 2007. For 2007, $18 million over three years would be $6 million for 2007. Thus, the total expense recognized in 2007 would be $4 million + $5 million + $6 million = $15 million, instead of $18 million. The difference of $3 million would have been added to the net income, but this is before considering the tax effect. The tax saving from the $3 million expense is $3 million * 35% = $1.05 million. Therefore, the net increase in net income for 2007 after tax would be $3 million - $1.05 million = $1.95 million. Adding this to the originally reported net income of $20 million gives a revised net income of $21.95 million for fiscal 2007.

Tecktroniks Company Reported in Its Annual Report Software Refinement Expenses