FAR 8 Flashcards
West Corp. leased a building and received the $36,000 annual rental payment on June 15, 2004.
The beginning of the lease is July 1, 2004. Rental income is taxable when received. West’s tax rates are 30% for 2004 and 40% thereafter. West has elected early adoption of FASB Statement No. 109, Accounting for Income Taxes. West had no other permanent or temporary differences. West determined that no valuation allowance was needed.
What amount of deferred tax asset should West report in its December 31, 2004 balance sheet?
2004 rent revenue recognized for financial-accounting purposes is $18,000 (.50 x $36,000).
Rent revenue to be recognized for financial-accounting purposes after 2004 (remaining rent revenue)
$18,000
Less rent revenue taxable after 2004 (the entire $36,000 is taxable in 2004)
( 0)
Equals future deductible difference (future taxable income will be less than future pre-tax accounting income by this amount)
$18,000
Times future enacted tax rate
x .40
Equals ending deferred tax asset balance
$7,200
The future enacted tax rate is used to measure the deferred tax asset, because that is the tax rate that will be in effect when the deferred tax asset is realized.
At December 31, 2005, Bren Co. has the following deferred income tax items:
A deferred income tax liability of $15,000 related to a non-current asset
A deferred income tax asset of $3,000 related to a non-current liability
A deferred income tax asset of $8,000 related to a current liability
Which of the following should Bren report in the non-current section of its December 31, 2005 balance sheet?
The classification of deferred tax accounts is based on the underlying account to which they are related. The $15,000 income tax liability is related to a non-current asset. Therefore, that deferred tax liability is classified as non-current. Balance-sheet presentation of deferred tax accounts nets the non-current accounts and nets the current accounts, for a maximum of two net deferred accounts reported.
This firm would net the $15,000 non-current deferred tax liability with the $3,000 non-current deferred tax asset, to yield a net non-current deferred tax liability of $12,000.
In its first four years of operations ending December 31, 2002, Alder, Inc.’s depreciation for income tax purposes exceeds its depreciation for financial-statement purposes. This temporary difference is expected to reverse in 2003, 2004, and 2005. Alder had no other temporary difference and elected early adoption of FASB 109.
Alder’s 2002 balance sheet should include
The classification of deferred tax accounts is based on the classification of the underlying account giving rise to the deferred tax effect.
In this case, depreciable assets are non-current assets, therefore the deferred tax account is also classified as non-current. Because the future temporary differences are taxable (future tax depreciation will be less than book depreciation, causing future taxable income to exceed pre-tax accounting income), the deferred tax account is a liability. Future taxable temporary differences give rise to deferred tax liabilities.
On its December 31, 2005 balance sheet, Shin Co. has income tax payable of $13,000 and a current deferred tax asset of $20,000, before determining the need for a valuation account.
Shin had reported a current deferred tax asset of $15,000 at December 31, 2004. No estimated tax payments are made during 2005. At December 31, 2005, Shin determines that it is more likely than not that 10% of the deferred tax asset would not be realized.
In its 2005 income statement, what amount should Shin report as total income tax expense?
income tax expense is the net sum of the income tax liability for the year, the changes in the deferred tax accounts, and the change in the valuation account for deferred tax assets.
Tax liability (current portion of income tax expense): $13,000
Less increase in deferred tax asset: $20,000 - $15,000
($5,000)
Plus increase in valuation account: .10($20,000)
$2,000
Equals income tax expense
$10,000
The increase in the deferred tax asset causes income tax expense to decrease relative to the tax liability, because, as a result of transactions through the end of the current year, future taxable income will be reduced. This reduction is not realized in the current year as a reduction in the tax liability. Therefore, the anticipated future reduction is treated as an asset at the end of the current period. When realized, the asset is reduced in a future year.
The increase in the valuation allowance, which is contra to the deferred tax asset, reduces the deferred-tax-asset effect, because it is an amount of the deferred tax asset not likely to be realized.
At the end of the current year, Swen Inc. prepares its tax return, which reflects an uncertain amount, reducing the firm’s tax liability by $40,000. Swen estimates that, upon audit by the IRS, there is a 20% chance that the full $40,000 benefit will be upheld, and a 40% chance that the benefit will be only $25,000. As a result of the required recognition and measurement principles for uncertain tax positions, current-year income tax expense is reduced by what amount?
This is the largest amount, which has at least a 50% probability of occurring. The cumulative probability through this amount is 60%. A liability is recognized for the $15,000 of the total $40,000, which has less than a 50% chance of occurring.
How should a company report its decision to change from a cash-basis to an accrual-basis of accounting?
The accrual basis of accounting is required by GAAP. A change from an inappropriate method to the correct method is treated as an error correction. The procedure requires retrospective application, resulting in an after-tax cumulative adjustment to prior years’ earnings (called a Prior period adjustment) to the beginning balance in retained earnings.
In 2005, Brighton Co. changed from the individual-item approach to the aggregate approach in applying the lower of FIFO cost or market to inventories.
The cumulative effect of this change should be reported in Brighton’s financial statements as a
This accounting change is a change in the application of an accounting principle, which merits the reporting of a cumulative effect of accounting principle change.
Accounting-principle changes, as well as changes in the application of principles, are accounted for using the retrospective approach, which recognizes the effect of the change on all prior years affected as an adjustment to retained earnings at the beginning of the year of change.
The effect of a change in accounting principle that is inseparable from the effect of a change in accounting estimate should be reported
When an accounting principle change cannot be distinguished from an estimate change, it is accounted for as an estimate change. Changes in accounting estimate are accounted for currently and prospectively and are reported in income from continuing operations. The relevant accounts affected by the change are adjusted for the current and future years. The change is not retroactively applied.
When are accounting changes measured?
Accounting changes are measured as of the beginning of the year of change.
On January 1, 2002, Flax Co. purchased a machine for $528,000 and depreciated it by the straight-line method using an estimated useful life of eight years with no salvage value.
On January 1, 2005, Flax determines that the machine had a useful life of six years from the date of acquisition and will have a salvage value of $48,000. An accounting change is made in 2005 to reflect these additional data.
The accumulated depreciation for this machine should have a balance at December 31, 2005 of
This is a change in estimate. The new estimated useful life and salvage value are applied to the book value at the beginning of the year of the estimate change.
Accumulated depreciation, January 1, 2005 = $528,000(3/8) = $198,000
Book value, January 1, 2005 = $528,000 - $198,000 = $330,000 Depreciation, 2005 = ($330,000 - $48,000)/(6 - 3) = $94,000
Accumulated depreciation, 31 December 2005 $292,000
The denominator of the 2005 depreciation calculation (6 - 3) is the new total useful life of six years, less the three years for which the asset has been used as of January 1, 2005.
Cuthbert Industrials, Inc. prepares three-year comparative financial statements. In year 3, Cuthbert discovered an error in the previously issued financial statements for year 1. The error affects the financial statements that were issued in years 1 and 2. How should the company report the error?
When there is an error in prior period financial statements and those statements are presented with the current year, the error should be corrected in years 1 and 2 so they are comparative to year 3. The effect of the error should be reflected in the year 3 beginning balances of the appropriate asset and liabilities.
Choose the best description of accretion expense associated with an asset retirement obligation.
Accretion expense is simply the increase in the asset retirement obligation over time. The asset retirement obligation is initially recorded at present value or fair value and, over time, grows with interest until it reaches its future value - the amount due. Accretion expense is similar to the interest cost component of pension expense - the growth in projected benefit obligation. It is caused by the fact that the asset retirement obligation is recorded at present value but not paid until later.
At the beginning of the current year, a firm invested $30 million in a natural resources site. This amount was applied to the acquisition of the mineral rights, exploring for the resource (full-costing method is used), and development. In addition, the firm must bring the property back to its original state three years from today. Two estimates of the future cost for that future effort are: (1) $6 million with 30% probability, and (2) $4 million with 70% probability. 6% is the appropriate risk adjusted rate of return. The present value of $1 in three years at 6% is 0.83962. By the end of the current year, the firm had removed 20% of the total estimated resource in the deposit. Compute depletion and accretion expense for the current year.
Asset retirement obligation beginning balance = $6,000,000(.30) + $4,000,000(.70) = $3,862,252. This is the present value of the expected future cost of reclaiming the property. The risk-adjusted rate of return is used because the probabilities account for the uncertainty of the cash flow amounts. This beginning balance is added to the $30 million figure for a total of $33,862,252 capitalized depletion base. Depletion is 20% of that amount or $6,772,450. Accretion expense is the growth in the asset retirement obligation for the year or .06($3,862,252) = $231,735.
For business combinations, which one of the following statements correctly reflects the determination of the accounts and amounts for the entry to record the combination?
The legal form of a business combination determines the entry accounts (i.e., which accounts to debit and/or credit), and the accounting method (acquisition method) determines the amounts at which the entries will be made (i.e., fair value).
During September, Leer paid $450,000 in dividends to its stockholders. For the year ended December 31, 20x7, Yost Corp. issued parent company-only financial statements. These statements are not considered to be those of the primary reporting entity. Under the equity method, what is the amount of net income reported in Yost’s income statement?
This amount ($1,650,000) results from totaling Yost’s net income for the full twelve months ($1,500,000) and Leer’s net income earned from October 1 through December 31, 20x7 ($150,000), the period during which Yost owned 100% (all) of Leer’s voting common stock. The total net income recognized by a parent company using the equity method on its books will include its net income for the period plus its share of the investee’s net income from the date the parent acquired the subsidiary.
