Exam II (Ch 15-17)

What are the two ways to account for sale-leaseback arrangements?

(1) Sale-leaseback approach (2)Financing arrangement

For the lessor, a lease can be classified as

- Sales-type lease (with or without profit) -operating lease

What must companies disclose about NOL carryforwards?

- amount and expiration dates

Quantitative Disclosures for Lessees (cont)

- contractual obligations ( and options that the lessee is "reasonably certain" to exercise) for each of the five succeeding fiscal years plus a total for the remaining years - table of future lease payments, segregated by type of lease, for each of the next five years and total of payments for the remaining years and (for finance leases) reconciled with the balance sheet liabilties

What should disclosure notes indicate about income tax expense?

- current portion of the tax exp (or benefit) -deferred portion of the tax exp (or benefit) with sep. disclosure of amount attributable to: portions that do not include the effect of separately disclosed amounts, operating loss carryforwards - adjustments due to changes in the tax law or rate - adjustments to the beginning of the year valuation allowance due to revised estimates - tax credits

What are some key points about lease disclosure?

- extensive requirements must be disclosed for lessee and lessor - virtually all aspects of the lease agreement must be disclosed - lessees and lessors must provide disclosures that enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. - information disclosed is both qualitative and quantitative

For the lessee, a lease can be classified as

- finance lease -operating lease

Quantitative Disclosures for Lessees

- finance lease costs with separate disclosure of interest and amortization, operating lease cost, short-term lease cost, variable lease cost, weighted average lease term of operating leases and finance leases, weighted average discount rate, a reconciliation of opening and closing balances of the right of use asset

Differences without deferred tax consequences

- interest received from investments in bonds issued by state and municipal governments (not taxable) -investment expenses incurred to obtain tax-exempt income (not tax deductible) - life insurance proceeds on the death of an insured executive (not taxable) - premiums paid for life insurance policies when the payer is the beneficiary (not tax deductible ) - compensation expense pertaining to some employee stock option plans (not tax deductible) -expenses due to violations of the law (NTD) -difference in tax paid on foreign income permanently reinvested in the foreign country & the amount that would have been paid iftaxed at US rates -portion of dividends received from US corps. that is not taxable due to the dividends received deduction -tax deduction for depletion of natural resources (percentage depletion) that permanently exceeds the income statement depletion expense (cost depletion)

What do companies have to disclose about DTA/DTL?

- total of all DTA - total of all DTL - total valuation allowance recognized for DTA - net change in the valuation allowance - approximate tax effect of each type of temporary difference (and carryforward)

Quantitative disclosures for lessors

-information about lease contracts and significant assumptions and judgements - table of lease revenues received - lease sales disclosed separately from regular sales - table of future lease payments segragated by type of lease for each of the next five years, and total of payments thereafter and (for sales-type lease) reconciles with the balance sheet after receivables - information about assets under operating leases - information about risks associated with residual values -information about significant changes in unguaranteed residual values -the gross investment and net investment in the lease

How do you compute a tax expense?

1. First calculate the income tax that is payable currently 2. the calculate what the ending balance in the deferred tax liability (or asset) should be. 3. Then determine the change (debit or credit) in the deferred tax liability (or asset) necessary to reach that ending balance 4. Then combine that change with tax payable to determine income tax expense.

What happens in a sale-leaseback arrangement?

1. Seller-lessee receives cash from the sale of the asset 2. Seller-lessee pays periodic rent payments to the buyer-lessor to retain the use of the asset

How far can you carry back an NOL?

2 years

calculation for deferred tax liability or asset =

= temporary difference * currently enacted tax rate effective in the year(s) the temporary difference reverses

When coping with uncertainty, what is the first step in the decision process?

A tax benefit may be reflected in the financial statements only if it is "more likely than not" that the company will be able to sustain the tax return position, based on its technical merit.

When coping with uncertainty, what is the second step in the decision process?

A tax benefit should be measured as the largest amount of benefit that is "cumulatively greater than 50% likely to be realized"

How are temporary differences categorized?

All temp differences are categorized according to whether they create future taxable amounts or future deductible amounts.

Key points about Qualitative disclosure?

Disclosing information in notes to FS about variable lease payments would be more useful than estimating and including the payments in assets and liabilities

What are some reasons to enter a sale-leaseback?

Effectively refinance at a lower rate, & generate cash

What do lease payments include?

Fixed payments + exercise price for purch option if exercise is "reasonably certain" + termination penalty for termination option if exercise is "reasonably certain" + variable lease payments only if deemed in-substance fixed pmts or based on an index or rate + excess of guaranteed residual value over expected residual value

Summary of modification of a lease

If a modification grants the lessee an additional right-of-use, the original lease is terminated and a new lease is created... otherwise it means adjusting/adding/deleting accounts to confrom with the new terms perhaps reclassifying it from one type of lease to another.

Summary of purchase options?

If exercise is "reasonably certain" it limits lease term, PV of exercise price added to right-of-use asset and lease liability, PV of exercise price added to lease receivable

Summary of termination penalities

If exercise is "reasonably certain" it limits lease term, PV of penalty amount added to right-of-use asset and lease liability, PV of penalty amount added to lease receivable

What is a deferred tax liability?

If tax laws allow a company to avoid a current tax payment by postponing when an amount increases taxable income, the company must report a deferred tax liability based on the future taxable amount

What is a deferred tax asset?

If tax laws require the company to wait until a future period to take a tax deduction that reduces taxable income, the company reports a deferred tax asset reflecting the benefit of that future deductible amount

What is the key point with nonlease components of lease payments?

If the charge represents a transfer of a good or service to the lessee, then it qualifies as a nonlease component of the payment and should be separated from the lease payments

Summary of variable lease payments

Included only if payments are: In-substance fixed payments or based on an index or rate considered only if and when the lessee remeasures the lease liability for another reason

What is a tax expense?

It includes taxes payable as well as changes in deferred tax assets and liabilities. That means tax expense is a "plug" figure that balances the journal entry after accounting for tax payable and changes in deferred tax assets and liabilities

What are the five criteria a lease must meet to be a finance (lessee)/sales-type lease (lessor)?

It must meet one of the following - agreement specifies ownership of the asset transfers to the lessee - agreement contain a bargain purchase option that the lessee is reasonably certain to exercise - lease term is a "major part" of the remaining economic life of the underlying asset - the underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term

A nonlease component included in a periodic lease payment is paid by the _________, in effect indirectly paid by the ________ and expensed by the _______.

Lessor, lessee, lessee

What are Net operating losses (NOLs)?

NOLs are negative taxable income on the tax return

______ is payable in the year an NOL occurs

No tax

What do lease term include?

Non-cancelable period + period covered by renewal options if exercise is "reasonably certain" - periods following date of purch option if exercise is "reasonably certain" + periods covered by renewal options if under control of lessor + periods following date of termination option if it's "reasonably certain" the option will not be exercised

What is a lease term uncertainty?

Non-cancelable period for which a lessee has the right to use an underlying asset, modified by any renewal or termination options that are not exercised. Options whose exercise is under the control of the lessor are automatically included. Reassessed only when a significant occurrence indicates a change in the economic incentive

How do you classify DTL, DTA, and valuation allowances against DTA?

Noncurrent asset/liability

Summary of unguaranteed residual value?

Present value (called residual asset) influences the size of lease payments, added to lease receivable, subtracted from sales revenue and COGS in sales-type lease

Summary of lessee guaranteed residual value

Present value considered when determining lease classification (criterion 4), added to lease receivable, added to sales revenue

What is the key point in with the sale-leaseback approach?

Sale-leaseback approach is only allowed if the leaseback qualified as an operating lease

What can happen to specific tax rates when enacted tax rates differ?

Specific tax rates of each future year are multiplied by the amounts reversing in each of those years

Why do temporary differences arise in conceptual underpinning?

Temp. diff. arise when pretax accounting income and taxable income are recognized in different periods.

Why does conceptual underpinning occur?

The objectives of financial reporting and those of taxing authorities are not the same. Financial accounting standards are established to provide useful information to investors and creditors. Congress establishes tax regulations to allow it to raise funds in a socially acceptable manner and influence the behavior of taxpayers.

What is a sale-leaseback arrangement?

The owner of an asset sells it and immediately leases it back from the new owner.

What are temporary differences (conceptual underpinning)?

They are differences between the amount of an asset or liability that is reported in the FS and the equivalent amount called the tax basis or an asset or a liability, that is included in the company's tax records.

What can happen to existing tax laws when enacted tax rates differ?

They may call for enacted tax rates to be different in future years in which a temporary difference is expected to reverse.

Example of permanent differences: Interest received from investments in bond issued by state and municipal governments is exempt from taxation

This interest revenue is reported as revenue on the recipient's IS but not on its tax return. (perm difference between pretax accounting income and taxable income)

How many steps are in the decision process for coping with uncertainty in income taxes?

Two-step decision process: (1) more likely than not (2) cumulatively greater than 50 percent likely to be realized

What is the financing arrangement in a sale-leaseback arrangement?

View the arrangement, not as a sale, but as a loan by lessor to the lessee for the "sale" price. The asset remains on the lessee's books, and the leaseback is accounted for as debt. The "lease" payments are deemed to be repayment of the loan.

Qualitative disclosures

a general description of the leasing arrangement is required, including information about variable lease payments, options, nonlease payments, residual values.

Any existing tax liability or asset must be _______ to reflect a change in ___________.

adjusted, tax law or rate

Tax law permits _______ to be used to reduce taxable income in _____, ___________.

an NOL, other, profitable years

If deferred tax accounts relate to the same ______________ of the company and the same ___________, they are _________ against each other and shown as ______________ in the BS.

component of the company, tax jurisdiction, netted, a single number

A ____________ reflects the amount to be paid or recovered in the future, therefore it should change if legislation changes the amount.

deferred tax liability or asset

What are permanent differences in conceptual underpinning?

differences caused by transactions and events that under existing law, will never affect taxable income or taxes payable

Permanent differences affect the ___________________________, because they affect the relation between ____________ and __________________.

effective tax rate, tax expense, pretax accounting income

Changes in Tax Law/rates affect the amount that should be in the ___________ of the ________________. Therefore the change affects the __________ necessary to reach that balances so the change affects the _____________ in that year.

ending balance, deferred tax asset/liability, adjustment, income tax expense

________________ and ______________ do not transfer to the _________ a separate good or service and thus are part of the lease payments.

hazard insurance, property taxes, lessee

What is an NOL carryforward?

it creates a deferred tax asset

What is an NOL carryback?

it provides an immediate tax refund

List of the lease uncertainties

lease term, variable lease pmts, modification of a lease, residual values, purchase options, termination penalties

With a nonlease component, the ________ records a ROUA and lease liability for the PV of the lease payments excluding ____________.

lessee, nonlease components

The effect of a change in tax law/rate is reflected in __________ in the year the change is _______.

operating income, enacted

Why must companies disclose the amount and expiration date of NOL carryforward?

potential tax benefit can ...(1)foreshadow desirable cash savings for the company if earnings sufficient to absorb the NOL carryforwards are anticipated before their expiration date (2) make an unprofitable company an attractive target for acquisition

Summary of excess of guaranteed residual value over expected residual value?

present value influences size of lease payments, added to right-of-use asset and lease liability

What is the sale-leaseback approach?

records the sale of the asset including applicable gain or loss and the record a lease for the leaseback portion in accordance with standard lease guidance

Examples of nonlease components may include...

service contracts, maintenance, hazard insurance, property taxes

Most companies strive to reduce their overall ________ and to reduce or delay ____________.

tax burden, cash outflows for taxes

calculation for the effective tax rate =

tax expense / pretax accounting income

NOLs occur when ___________ exceed _______.

tax-deductible expenses, taxable revenues

The _______ _________ will never be reported on the tax return.

tax-free income

How to account for permanent differences

taxes payable are calculated according to the tax law and since permanent differences are never taxable, no deferred tax asset or liability is created.

What is conceptual underpinning?

the revenues and expenses (and gains/losses) included on the tax return may differ from those reported on the company's income statement for the same year

What do we do with future deductible amounts?

the total of the future deductible amount is multiplied by the future tax rate(s) to determine the appropriate balance for the deferred tax asset (DTA)

What do we do about future taxable amounts?

the total of the future taxable amounts is multiplied by the future tax rate(s) to determine the appropriate balance for the deferred tax liability (DTL)

Where do temporary differences in conceptual underpinning come from?

they originate in one period and reverse, or turns around in one or more subsequent periods

How far can you carryforward an NOL?

up to 20 years

When you have multiple temporary differences, you....

use the same approach that is used to reflect changes in tax laws.