Intermediate Chapters 19 + 21

A capitalized leased asset is always depreciated over the term of the lease by the lessee.

F

Under IFRS an affirmative judgment approach is used for recognizing deferred tax assets up to the amount that is probable to be realized.

T

Larsen Corporation reported $200,000 in revenues in its 2018 financial statements, of which $66,000 will not be included in the tax return until 2019. The enacted tax rate is 40% for 2018 and 35% for 2019. What amount should Larsen report for deferred income tax liability in its balance sheet at December 31, 2018?

a. $23,100 $66,000 × .35 = $23,100.

Munoz Corp.'s books showed pretax financial income of $3,600,000 for the year ended December 31, 2018. In the computation of federal income taxes, the following data were considered: Gain on an involuntary conversion $1,560,000 (Munoz has elected to replace the property within the statutory period using total proceeds.) Depreciation deducted for tax purposes in excess of depreciation deducted for book purposes 240,000 Federal estimated tax payments, 2018 300,000 Enacted federal tax rate, 2018 30% What amount should Munoz report as its current federal income tax liability on its December 31, 2018 balance sheet?

a. $240,000 ($3,600,000 - $1,560,000 - $240,000) × 30% = $540,000; $540,000 - $300,000 = $240,000.

In computing depreciation of a leased asset, the lessee should subtract

a. a guaranteed residual value and depreciate over the term of the lease.

Based on the following information, compute 2018 taxable income for South Co. assuming that its pre-tax accounting income for the year ended December 31, 2018 is $460,000. Future taxable Temporary difference (deductible) amount Installment sales $384,000 Depreciation $120,000 Unearned rent ($400,000)

b. $356,000 $460,000 - $384,000 - $120,000 + $400,000 = $356,000.

Alice, Inc. has the following deferred tax assets at December 31, 2017: Amount Related to $180,000 Rent revenue collected in advance related to 2018 $75,000 Warranty liability, expected to be paid in 2018 $255,000 Accrued liability related to a lawsuit expected to settle in 2021 What amount would Alice, Inc. report as a current deferred tax asset under IFRS and under GAAP? _IFRS_ GAAP

b. IFRS-$0 GAAP-$0

Jerome Co. has the following deferred tax liabilities at December 31, 2018: Amount Related to $100,000 Installment sales, expected to be collected in 2019 $350,000 Fixed asset, 10-year remaining useful life, 2018 tax depreciation exceeds book depreciation $90,000 Prepaid insurance related to 2019 What amount would Jerome Co. report as a noncurrent deferred tax liability under IFRS and under GAAP? IFRS GAAP

b. IFRS-$540,000 GAAP-$540,000

Khan, Inc. reports a taxable and financial loss of $2,250,000 for 2019. Its pretax financial income for the last two years was as follows: 2017 $900,000 2018 1,200,000 The amount that Khan, Inc. reports as a net loss for financial reporting purposes in 2019, assuming that it uses the carryback provisions, and that the tax rate is 30% for all periods affected, is

d. $1,575,000 loss. $2, 250,000 - (30% × $2, 250,000) = $1,575,000.

Pisa, Inc. leased equipment from Tower Company under a four-year lease requiring equal annual payments of $344,152, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4 year useful life and no salvage value. Pisa, Inc.'s incremental borrowing rate is 10% and the rate implicit in the lease (which is known by Pisa, Inc.) is 8%. Assuming that this lease is properly classified as a capital lease, what is the amount of principal reduction recorded when the second lease payment is made in Year 2? PV Annuity Due PV Ordinary Annuity 8%, 4 periods 3.57710 3.31213 10%, 4 periods 3.48685 3.16986

d. $273,199 $344,152 × 3.57710 = $1,231,066 $344,152 - [($1,231,066 - $344,152) × .08] = $273,199.

If the lease in a sale-leaseback transaction meets one of the four leasing criteria and is therefore accounted for as a capital lease, who records the asset on its books and which party records interest expense during the lease period? Party recording the Party recording asset on its books interest expense

d. Party recording the asset on its books- Seller-lessee Party recording interest expense-Seller-lessee

Which of the following is not considered a permanent difference?

d. Stock-based compensation expense.

The gross profit amount in a sales-type lease is greater when a guaranteed residual value exists.

F

The lessor will recover a greater net investment if the residual value is guaranteed instead of unguaranteed.

F

Under GAAP, the rate used to compute deferred taxes is either the enacted tax rate, or a substantially enacted tax rate (virtually certain).

F

Under IFRS, a deferred tax liability is classified as current or noncurrent based on the classification of the asset or liability to which it relates.

F

BE. 19-106—Future taxable and deductible amounts. Define temporary differences, future taxable amounts, and future deductible amounts.

Solution 19-106 Temporary differences are differences between the tax basis of an asset or liability and its reported amount in the financial statements that will result in taxable amounts or deductible amounts in future years. Future taxable amounts increase taxable income in future years and cause a deferred tax liability to be recorded. Future deductible amounts decrease taxable income in future years and cause a deferred tax asset to be recorded.

BE. 21-111—Capital lease amortization and journal entries. Hughey Co. as lessee records a capital lease of machinery on January 1, 2018. The seven annual lease payments of $875,000 are made at the end of each year. The present value of the lease payments at 10% is $4,260,000. Hughey uses the effective-interest method of amortization and sum-of-the-years'-digits depreciation (no residual value). Instructions (Round to the nearest dollar.) (a) Prepare an amortization table for 2018 and 2019. (b) Prepare all of Hughey's journal entries for 2018.

Solution 21-111 (a) Annual Reduction Date Payments 10% Interest of Liability Lease Liability 1/1/18 $4,260,000 12/31/18 $875,000 $426,000 $449,000 3,811,000 12/31/19 875,000 381,100 493,900 3,317,100 (b) Leased Equipment ......................................................................... 4,260,000 Lease Liability ..................................................................... 4,260,000 Interest Expense ............................................................................ 426,000 Lease Liability ................................................................................. 449,000 Cash ................................................................................... 875,000 Depreciation Expense (7/28 × $4,260,000) ................................... 1,065,000 Accumulated Depreciation ................................................ 1,065,000

Permanent differences do not give rise to future taxable or deductible amounts.

T

Taxable temporary differences will result in taxable amounts in future years when the related assets are recovered.

T

The FASB requires lessees and lessors to disclose certain information about leases in their financial statements or in the notes.

T

The primary difference between a direct-financing lease and a sales-type lease is the manufacturer's or dealer's gross profit (or loss).

T

The tax effect of a loss carryforward represents future tax savings and results in the recognition of a deferred tax asset.

T

Under IFRS, all potential liabilities associated with uncertain tax positions are recognized

T

When the lessee agrees to make up any deficiency below a stated amount that the lessor realizes in residual value, that stated amount is the guaranteed residual value.

T

In its 2018 income statement, Cohen Corp. reported depreciation of $3,700,000 and interest revenue on municipal obligations of $700,000. Cohen reported depreciation of $5,500,000 on its 2018 income tax return. The difference in depreciation is the only temporary difference, and it will reverse equally over the next three years. Cohen's enacted income tax rates are 35% for 2018, 30% for 2019, and 25% for 2020 and 2021. What amount should be included in the deferred income tax liability in Hertz's December 31, 2018 balance sheet?

a. $480,000 ($600,000 × 30%) + ($600,000 × 25%) + ($600,000 × 25%) = $480,000.

Wilcox Corporation reported the following results for its first three years of operation: 2017 income (before income taxes) $ 300,000 2018 loss (before income taxes) (2,700,000) 2019 income (before income taxes) 3,000,000 There were no permanent or temporary differences during these three years. Assume a corporate tax rate of 30% for 2017 and 2018, and 40% for 2019. 90. Assuming that Wilcox elects to use the carryforward provision and not the carryback provision, what income (loss) is reported in 2018?

b. $(1,620,000) ($2,700,000 × 40%) = $1,080,000; $2,700,000 - $1,080,000 = $1,620,000.

Mays Company has a machine with a cost of $750,000 which also is its fair value on the date the machine is leased to Park Company. The lease is for 6 years and the machine is estimated to have an unguaranteed residual value of $75,000. If the lessor's interest rate implicit in the lease is 12%, the six beginning-of-the-year lease payments would be

b. $154,623. [$750,000 - ($75,000 × .50663)] ÷ 4.60478 = $154,623.

On December 1, 2018, Goetz Corporation leased office space for 10 years at a monthly rental of $80,000. On that date Goetz paid the landlord the following amounts: Rent deposit $ 80,000 First month's rent 80,000 Last month's rent 80,000 Installation of new walls and offices 640,000 $880,000 The entire amount of $880,000 was charged to rent expense in 2018. What amount should Goetz have charged to expense for the year ended December 31, 2018?

b. $85,333 $80,000 + [($640,000 ÷ 10) x (1 ÷ 12)] = $85,333.

Which of the following best describes current practice in accounting for leases?

b. Leases similar to installment purchases are capitalized.

Pisa, Inc. leased equipment from Tower Company under a four-year lease requiring equal annual payments of $344,152, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4-year useful life and no salvage value. Pisa, Inc.'s incremental borrowing rate is 10% and the rate implicit in the lease (which is known by Pisa, Inc.) is 8%. Pisa, Inc. uses the straight-line method to depreciate similar assets. What is the amount of depreciation expense recorded by Pisa, Inc. in the first year of the asset's life? PV Annuity Due PV Ordinary Annuity 8%, 4 periods 3.57710 3.31213 10%, 4 periods 3.48685 3.16986

c. $307,767 $344,152 × 3.57710 = $1,231,066 ($1,231,066 - 0) ÷ 4 = $307,767.

Which of the following is a temporary difference classified as a revenue or gain that is taxable after it is recognized in financial income?

c. An installment sale accounted for on the accrual basis for financial reporting purposes and on the installment (cash) basis for tax purposes.

With regard to uncertain tax positions, the FASB requires that companies recognize a tax benefit when

c. it is more likely than not that the tax position will be sustained upon audit.

For a sales-type lease,

c. the gross profit will be the same whether the residual value is guaranteed or unguaranteed.

*Ex. 21-116—Lessee and lessor accounting (sale-leaseback). On January 1, 2018, Morris Company sells land to Lopez Corporation for $10,000,000, and immediately leases the land back. The following information relates to this transaction: 1. The term of the noncancelable lease is 20 years and the title transfers to Morris Company at the end of the lease term. 2. The land has a cost basis of $8,400,000 to Morris. 3. The lease agreement calls for equal rental payments of $943,074 at the beginning of each year. 4. The land has a fair value of $10,000,000 on January 1, 2018. 5. The incremental borrowing rate of Morris Company is 10%. Morris is aware that Lopez Corporation set the annual rentals to ensure a rate of return of 8%. 6. Morris Company pays all executory costs which total $255,000 in 2018. 7. Collectibility of the rentals is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. Instructions (a) Prepare the journal entries for the entire year 2018 on the books of Morris Company to reflect the above sale and lease transactions (include a partial amortization schedule and round all amounts to the nearest dollar.) (b) Prepare the journal entries for the entire year 2018 on the books of Lopez Corporation to reflect the above purchase and lease transactions.

*Solution 21-116 (a) Morris Company (Lessee) January 1, 2018 Cash ................................................................................................10,000,000 Land .................................................................................... 8,400,000 Unearned Profit on Sale-Leaseback .................................. 1,600,000 Leased Land ...................................................................................10,000,000 Lease Liability ..................................................................... 9,056,926 Cash .................................................................................... 943,074 Throughout 2018 Executory Costs (Insurance and Taxes) ........................................ 255,000 Accounts Payable and Cash .............................................. 255,000 December 31, 2018 Unearned Profit on Sale-Leaseback .............................................. 80,000 Revenue from Sale-Leaseback ($1,600,000 ÷ 20) ............ 80,000 Interest Expense ($9,056,926 × .08) .............................................. 724,554 Interest Payable .................................................................. 724,554 Partial Lease Amortization Schedule Annual Interest Reduction of Date Lease Payment 8% Lease Liability Balance 1/1/18 $10,000,000 1/1/18 $943,074 $-0- $943,074 9,056,926 (b) Lopez Corporation (Lessor) January 1, 2018 Land ................................................................................................ 10,000,000 Cash ................................................................................... 10,000,000 Cash ............................................................................................... 943,074 Lease Receivable ........................................................................... 9,056,926 Land .................................................................................... 10,000,000 December 31, 2018 Interest Receivable ......................................................................... 724,554 Interest Revenue ................................................................ 724,554

*Ex. 21-117—Sale-leaseback. On January 1, 2018, Hester Co. sells machinery to Beck Corp. at its fair value of $960,000 and leases it back. The machinery had a carrying value of $840,000, the lease is for 10 years and the implicit rate is 10%. The lease payments of $142,000 start on January 1, 2018. Hester uses straight-line depreciation and there is no residual value. Instructions (a) Prepare all of Hester's entries for 2018. (b) Prepare all of Beck's entries for 2018.

*Solution 21-117 (a) Hester Co. (Lessee) January 1, 2018 Cash ............................................................................................... 960,000 Equipment .......................................................................... 840,000 Unearned Profit on Sale-Leaseback .................................. 120,000 Leased Equipment ......................................................................... 960,000 Lease Liability ..................................................................... 960,000 Lease Liability ................................................................................. 142,000 Cash. .................................................................................. 142,000 December 31, 2018 Depreciation Expense .................................................................... 96,000 Accumulated Depreciation—Leased Equipment ............... 96,000 Unearned Profit on Sale-Leaseback .............................................. 12,000 Depreciation Expense ........................................................ 12,000 Interest Expense [10% × ($960,000 - $142,000)] ......................... 81,800 Interest Payable .................................................................. 81,800 (b) Beck Corp. (Lessor) January 1, 2018 Equipment ....................................................................................... 960,000 Cash .................................................................................... 960,000 Lease Receivable ........................................................................... 960,000 Equipment ........................................................................... 960,000 Cash ................................................................................................ 142,000 Lease Receivable ............................................................... 142,000 December 31, 2018 Interest Receivable ......................................................................... 81,800 Interest Revenue ................................................................. 81,800

Briefly describe some of the similarities and differences between GAAP and IFRS with respect to income tax accounting.

1. Both IFRS and GAAP use the asset and liability approach for recording deferred tax assets. In general, the differences between IFRS and GAAP involve limited differences in the exceptions to the asset-liability approach, some minor differences in the recognition, measurement and disclosure criteria, and differences in implementation guidance. Following are some key elements for comparison • Under IFRS, an affirmative judgment approach is used by which a deferred tax asset is recognized up to the amount that is probable to be realized. GAAP uses an impairment approach. In this approach, the deferred tax asset is recognized in full. It is then reduced by a valuation account if it is more likely than not that all or a portion of the deferred tax asset will not be realized. • IFRS uses the enacted tax rate or substantially enacted tax rate (Substantially enacted means virtually certain). For GAAP the enacted tax rate must be used. • The tax effects related to certain items are reported in equity under IFRS. That is not the case under GAAP, which charges or credits the tax effects to income. • GAAP requires companies to assess the likelihood of uncertain tax positions being sustainable upon audit. Potential liabilities must be accrued and disclosed if the position is "more likely than not" to be disallowed. Under IFRS, all potential liabilities must be recognized. With respect to measurement, IFRS uses an expected value approach to measure the tax liability which differs from GAAP.

Briefly describe some of the similarities and differences between GAAP and IFRS with respect to the accounting for leases.

Both GAAP and IFRS share the same objective of recording leases by lessees and lessors according to their economic substance - that is, according to the definitions of assets and liabilities. Leasing was on the FASB's initial agenda in 1973 and GAAP rules were issued in 1976 (before the conceptual framework was developed). GAAP for leases has been the subject of more than 30 interpretations since its issuance. The IFRS standard is subject to just three interpretations. One reason for this small number of interpretations is that IFRS does not specifically address a number of leasing transactions that are covered by GAAP. Examples include lease agreements for natural resources, sale-leasebacks, real estate leases, and leveraged leases. GAAP for leases is much more "rule-based" with specific bright-line criteria to determine if a lease arrangement transfers the risks and rewards of ownership; IFRS is more general in its provisions.

A company reduces a deferred tax asset by a valuation allowance if it is probable that it will not realize some portion of the deferred tax asset.

F

A company should add a decrease in a deferred tax liability to income taxes payable in computing income tax expense.

F

A lessee records interest expense in both a capital lease and an operating lease.

F

Because IFRS is very general in its provisions for lease accounting, the required disclosures for leases under IFRS are more detailed and extensive than those required under GAAP.

F

Both a guaranteed and an unguaranteed residual value affect the lessee's computation of amounts capitalized as a leased asset.

F

Companies should classify deferred tax accounts on the balance sheet as current assets or current liabilities.

F

Deductible amounts cause taxable income to be greater than pretax financial income in the future as a result of existing temporary differences.

F

Examples of taxable temporary differences are subscriptions received in advance and advance rental receipts.

F

IFRS for leases is more "rules-based" than GAAP and includes many bright-line criteria to determine ownership.

F

IFRS requires lessees to use their incremental rate, unless the implicit rate is known by the lessee and the implicit rate is lower than the incremental rate.

F

IFRS requires that companies provide a year-by-year breakout of future noncancelable lease payments due in years 1 through 5.

F

In computing the annual lease payments, the lessor deducts only a guaranteed residual value from the fair value of a leased asset.

F

Lessors classify and account for all leases that do not qualify as sales-type leases as operating leases.

F

Minimum rental payments are the same as minimum lease payments.

F

Pretax financial income is the amount used to compute income taxes payable.

F

Taxable income is a tax accounting term and is also referred to as income before taxes.

F

The FASB agrees with the capitalization approach and requires companies to capitalize all long-term leases.

F

The FASB believes that the deferred tax method is the most consistent method for accounting for income taxes.

F

The distinction between a direct-financing lease and a sales-type lease is the presence or absence of a transfer of title.

F

Under IFRS, all tax effects are charged or credited to income.

F

Under the loss carryback approach, companies must apply a current year loss to the most recent year first and then to an earlier year

F

Under the operating method, the lessor records each rental receipt as part interest revenue and part rental revenue.

F

When a change in the tax rate is enacted, the effect is reported as an adjustment to income tax payable in the period of the change.

F

With regard to recognition of deferred tax assets, IFRS requires Approach Recognition a. Affirmative judgment Recognize an asset up to the amount that is probable to be realized b. Impairment approach Recognize asset in full, reduced by valuation allowance if it's more likely than not that all or a portion of the asset won't be realized c. Affirmative judgment Recognize asset in full, reduced by valuation allowance if it's more likely than not that all or a portion of the asset won't be realized d. Impairment approach Recognize an asset up to the amount that is probable to be realized

Match the approach, IFRS or GAAP, with the location where tax effects are reported: Approach Location a. IFRS Charge or credit only taxable temporary differences to income b. GAAP Charge or credit certain tax effects to equity c. IFRS Charge or credit certain tax effects to equity d. GAAP Charge or credit only deductible temporary differences to income

BE. 19-105—Computation of taxable income. The records for Bosch Co. show this data for 2018: • Gross profit on installment sales recorded on the books was $480,000. Gross profit from collections of installment receivables was $320,000. • Life insurance on officers was $3,800. • Machinery was acquired in January for $300,000. Straight-line depreciation over a ten-year life (no salvage value) is used. For tax purposes, MACRS depreciation is used and Bosch may deduct 14% for 2018. • Interest received on tax exempt Iowa State bonds was $9,000. • The estimated warranty liability related to 2018 sales was $21,600. Repair costs under warranties during 2018 were $13,600. The remainder will be incurred in 2019. • Pretax financial income is $700,000. The tax rate is 30%. • Instructions (a) Prepare a schedule starting with pretax financial income and compute taxable income. (b) Prepare the journal entry to record income taxes for 2018.

Solution 19-105 (a) Pretax financial income $700,000 Permanent differences Life insurance 3,800 Tax-exempt interest (9,000) Temporary differences Installment sales ($480,000 - $320,000) (160,000) Extra depreciation ($42,000 - $30,000) (12,000) Warranties ($21,600 - $13,600) 8,000 Taxable income $530,800 (b) Income Tax Expense [$159,240 + ($51,600 - $2,400)] ............... 208,440 Deferred Tax Asset (30% × $8,000) ............................................. 2,400 Deferred Tax Liability (30% × $172,000) .......................... 51,600 Income Taxes Payable (30% × $530,800) ....................... 159,240

BE. 19-107—Deferred income taxes. Pole Co. at the end of 2018, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $ 520,000 Extra depreciation taken for tax purposes (1,200,000) Estimated expenses deductible for taxes when paid 890,000 Taxable income $ 210,000 Use of the depreciable assets will result in taxable amounts of $400,000 in each of the next three years. The estimated litigation expenses of $890,000 will be deductible in 2021 when settlement is expected. Instructions (a) Prepare a schedule of future taxable and deductible amounts. (b) Prepare the journal entry to record income tax expense, deferred taxes, and income taxes payable for 2018, assuming a tax rate of 40% for all years.

Solution 19-107 (a) 2019 2020 2021 Total Future taxable (deductible) amounts Extra depreciation $400,000 $400,000 $400,000 $1,200,000 Litigation (890,000) (890,000) (b) Income Tax Expense ($84,000 + $480,000 - $356,000) .............. 208,000 Deferred Tax Asset ($890,000 × 40%) .......................................... 356,000 Deferred Tax Liability ($1,200,000 × 40%) ........................ 480,000 Income Taxes Payable ($210,000 × 40%) ........................ 84,000

Ex. 19-108—Deferred income taxes. Hunt Co. at the end of 2018, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $ 950,000 Estimated warranty expenses deductible for taxes when paid 1,200,000 Extra depreciation (1, 950,000) Taxable income $ 200,000 Estimated warranty expense of $800,000 will be deductible in 2019, $300,000 in 2020, and $100,000 in 2021. The use of the depreciable assets will result in taxable amounts of $650,000 in each of the next three years. Instructions (a) Prepare a table of future taxable and deductible amounts. (b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2018, assuming an income tax rate of 40% for all years.

Solution 19-108 (a) 2019 2020 2021 Total Future taxable (deductible) amounts Warranties $(800,000) $(300,000) $(100,000) $(1,200,000) Excess depreciation 650,000 650,000 650,000 1, 950,000 (b) Income Tax Expense [$80,000 + ($780,000 - $480,000)] ............ 380,000 Deferred Tax Asset ($1,200,000 × 40%) ....................................... 480,000 Deferred Tax Liability ($1, 950,000 × 40%) ...................... 780,000 Income Taxes Payable ($200,000 × 40%) ....................... 80,000

Ex. 19-109—Recognition of deferred tax asset. (a) Describe a deferred tax asset. (b) When should a deferred tax asset be reduced by a valuation allowance?

Solution 19-109 (a) A deferred tax asset is the deferred tax consequences attributable to deductible temporary differences and operating loss carryforwards. (b) A deferred tax asset should be reduced by a valuation allowance if, based on all available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. More likely than not means a level of likelihood that is at least slightly more than 50%.

Ex. 19-110—Permanent and temporary differences. Listed below are items that are treated differently for accounting purposes than they are for tax purposes. Indicate whether the items are permanent differences or temporary differences. For temporary differences, indicate whether they will create deferred tax assets or deferred tax liabilities. 1. Investments accounted for by the equity method (ignore dividends received deduction). 2. Advance rental receipts. 3. Fine for polluting. 4. Estimated future warranty costs. 5. Excess of contributions over pension expense. 6. Expenses incurred in obtaining tax-exempt revenue. 7. Installment sales. 8. Excess tax depreciation over accounting depreciation. 9. Long-term construction contracts. 10. Premiums paid on life insurance of officers (company is the beneficiary).

Solution 19-110 1. Temporary difference, deferred tax liability. 2. Temporary difference, deferred tax asset. 3. Permanent difference. 4. Temporary difference, deferred tax asset. 5. Temporary difference, deferred tax liability. 6. Permanent difference. 7. Temporary difference, deferred tax liability. 8. Temporary difference, deferred tax liability. 9. Temporary difference, deferred tax liability. 10. Permanent difference.

Ex. 19-111—Permanent and temporary differences. Indicate and explain whether each of the following independent situations should be treated as a temporary difference or a permanent difference. (a) For accounting purposes, a company reports revenue from installment sales on the accrual basis. For income tax purposes, it reports the revenues by the installment-sales method, deferring recognition of gross profit until cash is collected. (b) Pretax accounting income and taxable income differ because 80% of dividends received from U.S. corporations was deducted from taxable income, while 100% of the dividends received was reported for financial statement purposes. (c) Estimated warranty costs (covering a three-year warranty) are expensed for accounting purposes at the time of sale but deducted for income tax purposes when paid.

Solution 19-111 (a) Temporary difference. This difference in the timing of revenue recognition for pretax financial income and taxable income will initially increase pretax financial income, but will increase taxable income by the amount of deferred gross profits as cash is collected in subsequent years. Assuming the estimate as to collectibility of installment receivables is valid, the total amounts reported as gross profits for accounting purposes and for tax purposes will be equal over the life of a group of installment receivables. The time lag between the accrual for accounting purposes and the recognition for tax purposes will result in credit entries to a company's deferred tax liability as long as installment sales are level or increasing. The credit entries related to particular installment receivables will be "drawn down," or reversed, however, when the receivables are collected. (b) Permanent difference. This difference in pretax financial income and taxable income will never reverse because present tax laws allow a company that owns stock in another U.S. corporation to deduct 80% of the dividends it receives from that company. Taxes will not be paid on the dividends deducted and there are no tax consequences for those dividends, even though they are recognized as income for book purposes. (c) Temporary difference. The full estimated three years of warranty expenses reduce the current year's pretax financial income, but will reduce taxable income in varying amounts each year as paid. Assuming the estimate for each warranty is valid, the total amounts deducted for accounting and for tax purposes will be equal over the three-year period for each warranty. This is an example of an expense that, in the first period, reduces pretax financial income more than taxable income and, in later years, reverses and reduces taxable income without affecting pretax financial income.

Ex. 19-112—Temporary differences. There are four types of temporary differences. For each type: (1) indicate the type and cause of the difference, (2) give an example, and (3) indicate whether it will create a taxable or deductible amount in the future.

Solution 19-112 (a) Revenues or gains are taxable after they are recognized in pretax financial income. Examples are installment sales, long-term construction contracts, and the equity method of accounting for investments. They result in future taxable amounts. (b) Revenues or gains are taxable before they are recognized in pretax financial income. Examples are subscriptions received in advance and rents received in advance. They result in future deductible amounts. (c) Expenses or losses are deductible before they are recognized in pretax financial income. Examples are extra depreciation, prepaid expenses, and pension funding in excess of pension expense. They result in future taxable amounts. (d) Expenses or losses are deductible after they are recognized in pretax financial income. Examples are warranty expenses, estimated litigation losses, and unrealized holding losses. They result in future deductible amounts.

Ex. 19-113—Operating loss carryforward. In 2018, its first year of operations, Kimble Corp. has a $900,000 net operating loss when the tax rate is 30%. In 2019, Kimble has $250,000 taxable income and the tax rate remains 30%. Instructions Assume the management of Kimble Corp. thinks that it is more likely than not that the loss carryforward will not be realized in the near future because it is a new company (this is before results of 2019 operations are known). (a) What are the entries in 2018 to record the tax effects of the loss carryforward? (b) What entries would be made in 2019 to record the current and deferred income taxes and to recognize the loss carryforward? (Assume that at the end of 2019 it is more likely than not that the deferred tax asset will be realized.)

Solution 19-113 (a) Deferred Tax Asset ($900,000 × 30%) ........................................... 270,000 Benefit Due to Loss Carryforward ...................................... 270,000 Benefit Due to Loss Carryforward .................................................. 270,000 Allowance to Reduce Deferred Tax Asset to Expected Realizable Value ............................................ 270,000 (b) Income Tax Expense ($250,000 × 30%) ........................................ 75,000 Deferred Tax Asset ............................................................. 75,000 Allowance to Reduce Deferred Tax Asset to Expected Realizable Value ........................................................................ 75,000 Benefit Due to Loss Carryforward ...................................... 75,000

PROBLEMS Pr. 19-114—Differences between accounting and taxable income and the effect on deferred taxes. The following differences enter into the reconciliation of financial income and taxable income of Abbott Company for the year ended December 31, 2017, its first year of operations. The enacted income tax rate is 30% for all years. Pretax accounting income $800,000 Excess tax depreciation (480,000) Litigation accrual 70,000 Unearned rent revenue deferred on the books but appropriately recognized in taxable income 60,000 Interest income from New York municipal bonds (20,000) Taxable income $430,000 Pr. 19-114 (cont.) 1. Excess tax depreciation will reverse equally over a four-year period, 2018-2021. 2. It is estimated that the litigation liability will be paid in 2021. 3. Rent revenue will be recognized during the last year of the lease, 2021. 4. Interest revenue from the New York bonds is expected to be $20,000 each year until their maturity at the end of 2021. Instructions (a) Prepare a schedule of future taxable and (deductible) amounts. (b) Prepare a schedule of the deferred tax (asset) and liability at the end of 2017. (c) Since this is the first year of operations, there is no beginning deferred tax asset or liability. Compute the net deferred tax expense (benefit). (d) Prepare the journal entry to record income tax expense, deferred taxes, and the income taxes payable for 2017.

Solution 19-114 (a) 2018 2019 2020 2021 Total Future taxable (deductible) amounts: Depreciation $120,000 $120,000 $120,000 $120,000 $480,000 Litigation (70,000) (70,000) Unearned rent (60,000) (60,000) (b) Future Taxable (Deductible) Deferred Tax Temporary Differences Amounts Tax Rate (Asset) Liability Depreciation $480,000 30% $144,000 Litigation (70,000) 30% $(21,000) Unearned rent (60,000) 30% (18,000) Totals $350,000 $(39,000) $144,000 (c) Deferred tax expense $144,000 Deferred tax benefit (39,000) Net deferred tax expense $105,000 (d) Income Tax Expense ($129,000 + $105,000) ............................... 234,000 Deferred Tax Asset ....................................................................... 39,000 Deferred Tax Liability ........................................................ 144,000 Income Taxes Payable ($430,000 × 30%) ....................... 129,000

Pr. 19-115—Multiple temporary differences. The following information is available for the first three years of operations for Cooper Company: 1. Year Taxable Income 2017 $500,000 2018 375,000 2019 400,000 2. On January 2, 2017, heavy equipment costing $800,000 was purchased. The equipment had a life of 5 years and no salvage value. The straight-line method of depreciation is used for book purposes and the tax depreciation taken each year is listed below: Tax Depreciation 2017 2018 2019 2020 Total $264,000 $360,000 $120,000 $56,000 $800,000 3. On January 2, 2018, $360,000 was collected in advance for rental of a building for a threeyear period. The entire $360,000 was reported as taxable income in 2018, but $240,000 of the $360,000 was reported as unearned revenue at December 31, 2018 for book purposes. 4. The enacted tax rates are 40% for all years. Instructions (a) Prepare a schedule comparing depreciation for financial reporting and tax purposes. (b) Determine the deferred tax (asset) or liability at the end of 2017. (c) Prepare a schedule of future taxable and (deductible) amounts at the end of 2018. (d) Prepare a schedule of the deferred tax (asset) and liability at the end of 2018. (e) Compute the net deferred tax expense (benefit) for 2018. (f) Prepare the journal entry to record income tax expense, deferred income taxes, and income tax payable for 2018.

Solution 19-115 (a) Depreciation for Financial Depreciation for Temporary Year Reporting Purposes Tax Purposes Difference 2017 $160,000 $264,000 $ (104,000) 2018 160,000 360,000 (200,000) 2019 160,000 120,000 40,000 2020 160,000 56,000 104,000 2021 160,000 -0- 160,000 $800,000 $800,000 $ -0- (b) 2018 2019 2020 2021 Total Future taxable (deductible) amounts: Depreciation $(200,000) $40,000 $104,000 $160,000 $104,000 Deferred tax liability: $104,000 × 40% = $41, 600 at the end of 2017. (c) 2019 2020 2021 Total Future taxable (deductible) amounts: Depreciation $40,000 $104,000 $160,000 $304,000 Rent (120,000) (120,000) (240,000) (d) Future Taxable (Deductible) Tax Deferred Tax Temporary Differences Amounts Rate (Asset) Liability Depreciation $304,000 40% $121,600 Rent (240,000) 40% $(96,000) Totals $ 64,000 $(96,000) $121,600 (e) Deferred tax asset at end of 2018 $(96,000) Deferred tax asset at beginning of 2018 -0- Deferred tax (benefit) $(96,000) Deferred tax liability at end of 2018 $121,600 Deferred tax liability at beginning of 2018 41,600 Deferred tax expense $80,000 Deferred tax (benefit) $(96,000) Deferred tax expense 80,000 Net deferred tax benefit for 2018 *$(16,000) (f) Income Tax Expense ($150,000 - *$16,000) ................................ 134,000 Deferred Tax Asset ........................................................................ 96,000 Deferred Tax Liability ......................................................... 80,000 Income Taxes Payable ($375,000 × 40%) ........................ 150,000

Pr. 19-116—Deferred tax asset. Farmer Inc. began business on January 1, 2018. Its pretax financial income for the first 2 years was as follows: 2018 $240,000 2019 560,000 The following items caused the only differences between pretax financial income and taxable income. 1. In 2018, the company collected $420,000 of rent; of this amount, $140,000 was earned in 2018; the other $280,000 will be earned equally over the 2019-2020 period. The full $420,000 was included in taxable income in 2018. 2. The company pays $10,000 a year for life insurance on officers. 3. In 2019, the company terminated a top executive and agreed to $90,000 of severance pay. The amount will be paid $30,000 per year for 2019-2021. The 2019 payment was made. The $90,000 was expensed in 2019. For tax purposes, the severance pay is deductible as it is paid. The enacted tax rates existing at December 31, 2018 are: 2018 30% 2020 40% 2019 35% 2021 40% Instructions (a) Determine taxable income for 2018 and 2019. (b) Determine the deferred income taxes at the end of 2018, and prepare the journal entry to record income taxes for 2018. (c) Prepare a schedule of future taxable and (deductible) amounts at the end of 2019. (d) Prepare a schedule of the deferred tax (asset) and liability at the end of 2019. (e) Compute the net deferred tax expense (benefit) for 2019. (f) Prepare the journal entry to record income taxes for 2019. (g) Show how the deferred income taxes should be reported on the balance sheet at December 31, 2019.

Solution 19-116 (a) 2018 2019 Pretax financial income $240,000 $560,000 Permanent differences: Life insurance 10,000 10,000 250,000 570,000 Temporary differences: Rent 280,000 (140,000) Severance pay -0- 60,000 Taxable income $530,000 $490,000 (b) 2019 2020 Total Future taxable (deductible) amounts: Rent $(140,000) $(140,000) $(280,000) Tax rate 35% 40% Deferred tax (asset) liability $(49,000) $(56,000) *$(105,000) at end of 2018 Income Tax Expense ($159,000 - *$105,000)............................... 54,000 Deferred Tax Asset ......................................................................... *105,000 Income Taxes Payable ($530,000 × 30%) ......................... 159,000 (c) 2020 2021 Total Future taxable (deductible) amounts: Rent $(140,000) $(140,000) Severance pay (30,000) $(30,000) (60,000) Solution 19-116 (cont.) (d) Future Taxable (Deductible) Tax Deferred Tax Temporary Difference Amounts Rate (Asset) Liability Rent $(140,000) 40% $(56,000) Severance pay (60,000) 40% (24,000) Totals $(200,000) $(80,000) (e) Deferred tax asset at end of 2019 $(80,000) Deferred tax asset at beginning of 2019 (105,000) Net deferred tax expense (benefit) for 2019 $(25,000) (f) Income Tax Expense ($171,500 + $25,000) ................................. 196,500 Deferred Tax Asset ............................................................ 25,000 Income Taxes Payable ($490,000 × 35%) ........................ 171,500 (g) The deferred income taxes should be reported on the December 31, 2019 balance sheet as follows: Other assets Deferred tax asset ($200,000* × 40%) $80,000 *$140,000 + $60,000

Pr. 19-117—Interperiod tax allocation with change in enacted tax rates. Murphy Company purchased equipment for $450,000 on January 2, 2017, its first day of operations. For book purposes, the equipment will be depreciated using the straight-line method over three years with no salvage value. Pretax financial income and taxable income are as follows: 2017 2018 2019 Pretax financial income $224,000 $260,000 $300,000 Taxable income 184,000 260,000 340,000 The temporary difference between pretax financial income and taxable income is due to the use of accelerated depreciation for tax purposes. Instructions (a) Prepare the journal entries to record income taxes for all three years (expense, deferrals, and liabilities) assuming that the enacted tax rate applicable to all three years is 30%. (b) Prepare the journal entries to record income taxes for all three years (expense, deferrals, and liabilities) assuming that the enacted tax rate as of 2017 is 30% but that in the middle of 2018, Congress raises the income tax rate to 35% retroactive to the beginning of 2018.

Solution 19-117 (a) 2017 2018 2019 Total Book depreciation $ 150,000 $150,000 $150,000 $450,000 Tax depreciation 190,000 150,000 110,000 450,000 Temporary difference $(40,000) $ -0- $40,000 $ -0- 2017 Income Tax Expense ($55,200 + $12,000) ........................ 67,200 Deferred Tax Liability ($40,000 × .30) .................... 12,000 Income Tax Payable ($184,000 × .30) ................... 55,200 2018 Income Tax Expense .......................................................... 78,000 Income Tax Payable ($260,000 × .30) ................... 78,000 2019 Income Tax Expense ($102,000 - $12,000) ....................... 90,000 Deferred Tax Liability ($40,000 × .30) ................................ 12,000 Income Tax Payable ($340,000 × .30) ................... 102,000 (b) 2017 Income Tax Expense ($55,200 + $12,000) ........................ 67,200 Deferred Tax Liability ($40,000 × .30) .................... 12,000 Income Tax Payable ($184,000 × .30) ................... 55,200 2018 Income Tax Expense ($91,000 + $2,000) .......................... 93,000 Deferred Tax Liability .............................................. 2,000* Income Tax Payable ($260,000 × .35) ................... 91,000 2019 Income Tax Expense ($119,000 - $14,000) ....................... 105,000 Deferred Tax Liability .......................................................... 14,000 Income Tax Payable ($340,000 × .35) ................... 119,000 2018 *Future taxable amount $40,000 Deferred tax @ 30% 12,000 Deferred tax @ 35% 14,000 Adjustment $ 2,000

BE. 21-110—Capital lease (Essay). Explain the procedures used by the lessee to account for a capital lease.

Solution 21-110 When the capital lease method is used, the lessee treats the lease transactions as if the asset were being purchased. The asset and liability are recorded at the lower of (1) the present value of the minimum lease payments (excluding executory costs) or (2) the fair value of the asset at the inception of the lease. The present value of the lease payments is computed using the lessee's incremental borrowing rate, unless the implicit rate used by the lessor is lower and the lessee has knowledge of it. The effective-interest method is used to allocate each lease payment between interest expense and a reduction of the lease liability. If the lease transfers ownership or contains a bargain purchase option, the asset is amortized in a manner consistent with the lessee's normal depreciation policy on assets owned, over the economic life of the asset and allowing for residual value. If the lease does not transfer ownership or contain a bargain purchase option, the leased asset is amortized over the lease term.

BE. 21-112—Operating lease. Maris Co. purchased a machine on January 1, 2018, for $2,500,000 for the express purpose of leasing it. The machine is expected to have a five-year life, no salvage value, and be depreciated on a straight-line monthly basis. On April 1, 2018, under a cancelable lease, Maris leased the machine to Dunbar Company for $750,000 a year for a four-year period ending March 31, 2022. Maris incurred total maintenance and other related costs under the provisions of the lease of $25,000 relating to the year ended December 31, 2018. Harley paid $750,000 to Maris on April 1, 2018. Instructions [Assume the operating method is appropriate for parts (a) and (b).] (a) Under the operating method, what should be the income before income taxes derived by Maris Co. from this lease for the year ended December 31, 2018? (b) What should be the amount of rent expense incurred by Dunbar from this lease for the year ended December 31, 2018?

Solution 21-112 (a) Revenue 4/1/18—12/31/18 ($750,000 × 9/12) $562,500 Expenses: Depreciation ($500,000 × 9/12) $375,000 Maintenance, etc. 25,000 400,000 Income before taxes $ 162,500 (b) Rent expense, 4/1/18—12/31/18 ($750,000 × 9/12) = $562,500.

Ex. 21-113—Lease criteria for classification by lessor. What are the criteria that must be satisfied for a lessor to classify a lease as a direct-financing or sales-type lease?

Solution 21-113 In order for a lessor to classify a lease as a direct-financing or a sales-type lease, the lease at the date of inception must satisfy one or more of the following Group I criteria (a, b, c, and d) and both of the following Group II criteria (a and b): Group I (a) The lease transfers ownership of the property to the lessee. (b) The lease contains a bargain purchase option. (c) The lease term is equal to 75% or more of the estimated economic life of the leased property. (d) The present value of the minimum lease payments (excluding executory costs) equals or exceeds 90% of the fair value of the leased property. Group II (a) Collectibility of the payments required from the lessee is reasonably predictable. (b) No important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor under the lease.

Ex. 21-114—Direct-financing lease (essay). Explain the procedures used to account for a direct-financing lease.

Solution 21-114 The lessor records the present value of the minimum lease payments (excluding executory costs) plus the present value of the unguaranteed residual value (a guaranteed residual value is included in the minimum lease payments) as Lease Receivable and removes the asset from the books. The lessor records payments received as a reduction in Lease Receivable and Interest Revenue. Interest revenue is recognized by using the effective-interest method. The implicit interest rate is applied to the declining balance of the Lease Receivable balance. The implicit rate is the rate of interest that will discount the minimum lease payments (excluding executory costs) and the unguaranteed residual value to the fair value of the asset at the inception of the lease.

Ex. 21-115—Lessor accounting—sales-type lease. Hayes Corp. is a manufacturer of truck trailers. On January 1, 2018, Hayes Corp. leases ten trailers to Lester Company under a six-year noncancelable lease agreement. The following information about the lease and the trailers is provided: 1. Equal annual payments that are due on January 1 each year provide Hayes Corp. with an 8% return on net investment (present value factor for 6 periods at 8% is 4.99271). 2. Titles to the trailers pass to Lester at the end of the lease. 3. The fair value of each trailer is $60,000. The cost of each trailer to Hayes Corp. is $54,000. Each trailer has an expected useful life of nine years. 4. Collectibility of the lease payments is reasonably predictable and there are no important uncertainties surrounding the amount of costs yet to be incurred by Hayes Corp. Instructions (a) What type of lease is this for the lessor? Discuss. (b) Calculate the annual lease payment. (Round to nearest dollar.) (c) Prepare a lease amortization schedule for Hayes Corp. for the first three years. (d) Prepare the journal entries for the lessor for 2018 to record the lease agreement, the receipt of the lease rentals, and the recognition of revenue (assume the use of a perpetual inventory method and round all amounts to the nearest dollar).

Solution 21-115 (a) It is a sales-type lease to the lessor, Hayes Corp. Hayes's (the manufacturer) profit upon sale is $60,000, which is recognized in the year of sale (2018). It is not an operating lease because title to the assets passes to the lessee, the present value ($600,000) of the minimum lease payments equals or exceeds 90% ($540,000) of the fair value of the leased trailers, collectibility is reasonably assured, and no important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor. The remaining accounting treatment is similar to that accorded a direct-financing lease. (b) ($60,000 × 10) ÷ 4.99271 = $120,175. (c) Lease Amortization Schedule (Lessor) Lease Annual Interest on Receivable Lease Date Lease Rental Lease Receivable Recovery Receivable 1/1/18 $600,000 1/1/18 $120,175 $-0- $'120,175 479,825 1/1/19 120,175 38,386 81,789 398,036 1/1/20 120,175 31,843 88,332 309,704 (d) January 1, 2018 Lease Receivable ........................................................................... 600,000 Cost of Goods Sold ........................................................................ 540,000 Sales Revenue ................................................................... 600,000 Inventory ............................................................................. 540,000 Cash ............................................................................................... 120,175 Lease Receivable ............................................................... 120,175 December 31, 2018 Interest Receivable .................................................................................. 38,386 Interest Revenue ................................................................ 38,386

Pr. 21-118—Lessee accounting—capital lease. Eubank Company, as lessee, enters into a lease agreement on July 1, 2018, for equipment. The following data are relevant to the lease agreement: 1. The term of the noncancelable lease is 4 years, with no renewal option. Payments of $978,446 are due on July 1 of each year. 2. The fair value of the equipment on July 1, 2018 is $3,500,000. The equipment has an economic life of 6 years with no salvage value. 3. Eubank depreciates similar machinery it owns on the sum-of-the-years'-digits basis. 4. The lessee pays all executory costs. 5. Eubank's incremental borrowing rate is 10% per year. The lessee is aware that the lessor used an implicit rate of 8% in computing the lease payments (present value factor for 4 periods at 8%, 3.57710; at 10%, 3.48685). Instructions (a) Indicate the type of lease Eubank Company has entered into and what accounting treatment is applicable. (b) Prepare the journal entries on Eubank's books that relate to the lease agreement for the following dates: (Round all amounts to the nearest dollar. Include a partial amortization schedule.) 1. July 1, 2018. 2. December 31, 2018. 3. July 1, 2019. 4. December 31, 2019.

Solution 21-118 (a) Capitalized amount: $978,446 × PV of an ordinary annuity for 4 periods at 8% $978,446 × 3.57710 = $3,500,000 Because the present value of the lease payments ($3,500,000) equals the fair value, $3,500,000, of the leased property, it is a capital lease and must be accounted for under the capital lease method. (b) 1. July 1, 2018 Leased Equipment ................................................................... 3,500,000 Lease Liability ............................................................... 2,521,554 Cash ............................................................................. 978,446 2. December 31, 2018 Depreciation Expense .............................................................. 700,000 Accumulated Depreciation—Capital Leases [($3,500,000 × 4/10) × 6/12] .................................... 700,000 Interest Expense ($201,724 × 6/12) ........................................ 100,862 Interest Payable ........................................................... 100,862 Lease Amortization Schedule Annual Interest on Reduction of Balance of Date Lease Payment Unpaid Liability Lease Liability Lease Liability 7/1/18 $2,521,554 7/1/19 $978,446 $201,724 $776,722 1,744,832 7/1/20 978,446 139,587 838,859 905,973 3. July 1, 2019 Interest Expense......................................................................... 201,724 Lease Liability ............................................................................. 776,722 Cash ................................................................................. 978,446 (Interest payable entry assumed to have been reversed 1/1/19) 4. December 31, 2019 Depreciation Expense ................................................................ 1,225,000 Accumulated Depreciation—Capital Leases ................... 1,225,000 [($3,500,000 × 4/10) × 6/12 plus ($3,500,000 × 3/10) × 6/12] Interest Expense ($139,587 × 6/12) .......................................... 69,794 Interest Payable ............................................................... 69,794

Pr. 21-119—Lessee accounting—capital lease. Krause Company on January 1, 2018, enters into a five-year noncancelable lease, with four renewal options of one year each, for equipment having an estimated useful life of 10 years and a fair value to the lessor, Daly Corp., at the inception of the lease of $4,000,000. Krause's incremental borrowing rate is 8%. Krause uses the straight-line method to depreciate its assets. The lease contains the following provisions: 1. Rental payments of $292,000 including $26,000 for property taxes, payable at the beginning of each six-month period. 2. A termination penalty assuring renewal of the lease for a period of four years after expiration of the initial lease term. 3. An option allowing the lessor to extend the lease one year beyond the last renewal exercised by the lessee. 4. A guarantee by Krause Company that Daly Corp. will realize $200,000 from selling the asset at the expiration of the lease. However, the actual residual value is expected to be $120,000. Instructions (a) What kind of lease is this to Krause Company? (b) What should be considered the lease term? (c) What are the minimum lease payments? (d) What is the present value of the minimum lease payments? (PV factor for annuity due of 20 semi-annual payments at 8% annual rate, 14.13394; PV factor for amount due in 20 semiannual interest periods at 8% annual rate, .45639.) (Round to nearest dollar.) (e) What journal entries would Krause record during the first year of the lease? (Include an amortization schedule through 1/1/19 and round to the nearest dollar.)

Solution 21-119 (a) This lease is a capital lease to Krause Company because its term (10 years—see computation in b below) exceeds 75% of the equipment's estimated useful life. In addition, the present value (see computation in d below) of the minimum lease payments (see computation in c below) exceeds 90% of the fair value of the equipment ($4,000,000). (b) The lease term is: Noncancelable period 5 years Additional period for which termination penalty assures renewal 4 years Period covered by lessor extension option 1 year 10 years (c) The minimum lease payments are: Semi-annual rental payments $ 292,000 Executory costs (26,000) 266,000 Number of payments over lease term × 20 5,320,000 Residual guarantee 200,000 Minimum lease payments $5,520,000 (d) The present value of the minimum lease payments is: Factor for present value of an annuity due, 20 periods, 4% 14.13394 Semi-annual payments, net of executory costs $ 266,000 3,759,628 Factor for present value of $1 due in 20 interest periods at 4% .45639 Residual guarantee × $200,000 91,278 Present value of lease payments $3,850,906 (e) January 1, 2018 Leased Equipment ......................................................................... 3,850,906 Lease Liability ..................................................................... 3,850,906 January 1, 2018 Lease Liability ................................................................................. 266,000 Property Tax Expense .................................................................... 26,000 Cash ................................................................................... 292,000 July 1, 2018 Lease Liability ................................................................................. 122,604 Property Tax Expense .................................................................... 26,000 Interest Expense ........................................................................... 143,396 Cash ................................................................................... 292,000 Lease Amortization Schedule Semi-Annual Interest Reduction of Date Lease Payment 4% Lease Liability Balance Initial PV $3,850,906 1/1/18 $266,000 — $266,000 3,584,906 7/1/18 266,000 143,396 122,604 3,462,302 1/1/19 266,000 138,492 127,508 3,334,794 Depreciation Expense ..................................................................... 373,091* Accumulated Depreciation—Capital Leases ...................... 373,091 *($3,850,906 - $120,000) ÷ 10 = $373,091. Interest Expense ............................................................................. 138,492 Interest Payable ................................................................. 138,492

Pr. 21-120—Lessor accounting—direct-financing lease. Lucas, Inc. enters into a lease agreement as lessor on January 1, 2018, to lease an airplane to National Airlines. The term of the noncancelable lease is eight years and payments are required at the end of each year. The following information relates to this agreement: 1. National Airlines has the option to purchase the airplane for $16,000,000 when the lease expires at which time the fair value is expected to be $27,000,000. 2. The airplane has a cost of $68,000,000 to Lucas, an estimated useful life of fourteen years, and a salvage value of zero at the end of that time (due to technological obsolescence). 3. National Airlines will pay all executory costs related to the leased airplane. 4. Annual beginning of year lease payments of $9,563,671 allow Lucas to earn an 8% return on its investment. 5. Collectibility of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by Lucas. Instructions (a) What type of lease is this? Discuss. (b) Prepare a lease amortization schedule for the lessor for the first two years (2018-2019). (Round all amounts to nearest dollar.) (c) Prepare the journal entries on the books of the lessor to record the lease agreement, to reflect payments received under the lease, and to recognize revenue, for 2018.

Solution 21-120 (a) The lease is a direct-financing type lease from the lessor's point of view or a capital lease from the lessee's point of view. The lease contains a bargain purchase option which satisfies one of the criteria for classification as a direct-financing lease. The option to buy for $16,000,000 at the termination of the lease when the asset is expected to have a fair value of $27,000,000 constitutes a bargain purchase option. Additionally, the payments are collectible, and there are no uncertainties as to future lessor costs. (b) Lessor's Lease Amortization Schedule Annual Interest on Lease Receivable Date Lease Payment Lease Receivable Recovery Lease Receivable 1/1/18 $68,000,000 1/1/18 $9,563,671* $-0- $9,563,671 58,436,329 1/1/19 9,563,671 4,674,906 4,888,765 53,547,564 *[$68,000,000 - ($16,000,000 × .54027)] ÷ 6.20637 = $9,563,671. (c) Cash 9,563,671 Lease Receivable .......................................................................... 58,436,329 Airplanes ............................................................................ 68,000,000 December 31, 2018 Interest Receivable ........................................................................ 4,674,906 Interest Revenue ............................................................... 4,674,906

A benefit of leasing to the lessor is the return of the leased property at the end of the lease term.

T

A deferred tax asset represents the increase in taxes refundable in future years as a result of deductible temporary differences existing at the end of the current year.

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A deferred tax liability represents the increase in taxes payable in future years as a result of taxable temporary differences existing at the end of the current year.

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A possible source of taxable income that may be available to realize a tax benefit for loss carryforwards is future reversals of existing taxable temporary differences.

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Companies are permitted to offset any balances in income taxes payable against related income tax refund receivable or prepaid income taxes balances.

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Companies must consider presently enacted changes in the tax rate that become effective in future years when determining the tax rate to apply to existing temporary differences.

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Companies must periodically review the estimated unguaranteed residual value in a sales-type lease.

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Companies should consider both positive and negative evidence to determine whether it needs to record a valuation allowance to reduce a deferred tax asset.

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Deferred tax expense is the increase in the deferred tax liability balance from the beginning to the end of the accounting period.

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Direct-financing leases are in substance the financing of an asset purchase by the lessee.

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Executory costs should be excluded by the lessee in computing the present value of the minimum lease payments.

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From the lessee's viewpoint, an unguaranteed residual value is the same as no residual value in terms of computing the minimum lease payments.

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IFRS does not provide detailed guidance for leases of natural resources, sale-leasebacks, and leveraged leases.

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Leasing equipment reduces the risk of obsolescence to the lessee and in many cases passes the risk of residual value to the lessor.

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Nickerson Corporation began operations in 2016. There have been no permanent or temporary differences to account for since the inception of the business. The following data are available: Year 2016 2017 2018 2019 Enacted Tax Rate 45% 40% 35% 30% Taxable Income $2,000,000 2,400,000 Taxes Paid $900,000 960,000 In 2018, Nickerson had an operating loss of $2,480,000. What amount of income tax benefits should be reported on the 2018 income statement due to this loss assuming that it uses the carryback provision?

a. $1,092,000 ($2,000,000 × .45) + [($2,480,000 - $2,000,000) × .40] = $1,092,000.

On December 31, 2018, Burton, Inc. leased machinery with a fair value of $1,575,000 from Cey Rentals Co. The agreement is a six-year noncancelable lease requiring annual payments of $300,000 beginning December 31, 2018. The lease is appropriately accounted for by Burton as a capital lease. Burton's incremental borrowing rate is 11%. Burton knows the interest rate implicit in the lease payments is 10%. The present value of an annuity due of 1 for 6 years at 10% is 4.7908. The present value of an annuity due of 1 for 6 years at 11% is 4.6959. In its December 31, 2018 balance sheet, Burton should report a lease liability of

a. $1,137,240. ($300,000 × 4.7908) - $300,000 = $1,137,240.

Pisa, Inc. leased equipment from Tower Company under a four-year lease requiring equal annual payments of $344,152, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4-year useful life and no salvage value. If Pisa, Inc.'s incremental borrowing rate is 10% and the rate implicit in the lease (which is known by Pisa, Inc.) is 8%, what is the amount recorded for the leased asset at the lease inception? PV Annuity Due PV Ordinary Annuity 8%, 4 periods 3.57710 3.31213 10%, 4 periods 3.48685 3.16986

a. $1,231,066 $344,152 × 3.57710 = $1,231,066.

Horner Corporation has a deferred tax asset at December 31, 2019 of $200,000 due to the recognition of potential tax benefits of an operating loss carryforward. The enacted tax rates are as follows: 40% for 2016-2018; 35% for 2019; and 30% for 2020 and thereafter. Assuming that management expects that only 50% of the related benefits will actually be realized, a valuation account should be established in the amount of:

a. $100,000 $200,000 × .50 = $100,000.

Mitchell Corporation prepared the following reconciliation for its first year of operations: Pretax financial income for 2018 $ 1,800,000 Tax exempt interest (150,000) Originating temporary difference (350,000) Taxable income $1,300,000 The temporary difference will reverse evenly over the next two years at an enacted tax rate of 40%. The enacted tax rate for 2018 is 35%. 66. What amount should be reported in its 2018 income statement as the deferred portion of income tax expense?

a. $140,000 debit $350,000 × .40 = $140,000 credit.

Lehman Corporation purchased a machine on January 2, 2017, for $4,000,000. The machine has an estimated 5-year life with no salvage value. The straight-line method of depreciation is being used for financial statement purposes and the following MACRS amounts will be deducted for tax purposes: 2017 $800,000 2020 $460,000 2018 1,280,000 2021 460,000 2019 768,000 2022 232,000 Assuming an income tax rate of 30% for all years, the net deferred tax liability that should be reflected on Lehman's balance sheet at December 31, 2018 be

a. $144,000 ($1,280,000 - $800,000) × 30% = $144,000 Noncurrent.

Haag Corp.'s 2018 income statement showed pretax accounting income of $2,500,000. To compute the federal income tax liability, the following 2018 data are provided: Income from exempt municipal bonds $ 100,000 Depreciation deducted for tax purposes in excess of depreciation deducted for financial statement purposes 200,000 Estimated federal income tax payments made 500,000 Enacted corporate income tax rate 30% What amount of current federal income tax liability should be included in Hagg's December 31, 2018 balance sheet?

a. $160,000 ($2,500,000 - $100,000 - $200,000) × 30% = $660,000; $660,000 - $500,000 = $160,000.

Haystack, Inc. manufactures machinery used in the mining industry. On January 2, 2018 it leased equipment with a cost of $480,000 to Silver Point Co. The 5-year lease calls for a 10% down payment and equal annual payments at the end of each year. The equipment has an expected useful life of 5 years. If the selling price of the equipment is $780,000, and the rate implicit in the lease is 8%, what are the equal annual payments? PV Annuity Due PV Ordinary Annuity PV Single Sum 8%, 5 periods 4.31213 3.99271 .68508 10%, 5 periods 4.16986 3.79079 .62092

a. $175,820 ($780,000 × .90) ÷ 3.99271 = $175,820.

Lyons Company deducts insurance expense of $210,000 for tax purposes in 2018, but the expense is not yet recognized for accounting purposes. In 2019, 2020, and 2021, no insurance expense will be deducted for tax purposes, but $70,000 of insurance expense will be reported for accounting purposes in each of these years. Lyons Company has a tax rate of 40% and income taxes payable of $180,000 at the end of 2018. There were no deferred taxes at the beginning of 2018. 71.What is the amount of income tax expense for 2018?

a. $264,000 $180,000 + ($210,000 × .40) = $264,000.

Rodd Co. reports a taxable and pretax financial loss of $900,000 for 2018. Rodd's taxable and pretax financial income and tax rates for the last two years were: 2016 $900,000 30% 2017 900,000 35% The amount that Rodd should report as an income tax refund receivable in 2018, assuming that it uses the carryback provisions and that the tax rate is 40% in 2018, is

a. $270,000. ($900,000 × 30%) = $270,000.

Metro Company, a dealer in machinery and equipment, leased equipment to Sands, Inc., on July 1, 2018. The lease is appropriately accounted for as a sales-type lease by Metro and as a capital lease by Sands. The lease is for a 10-year period (the useful life of the asset) expiring June 30, 2028. The first of 10 equal annual payments of $828,000 was made on July 1, 2018. Metro had purchased the equipment for $5,250,000 on January 1, 2018, and established a list selling price of $7,200,000 on the equipment. Assume that the present value at July 1, 2018, of the rent payments over the lease term discounted at 8% (the appropriate interest rate) was $6,000,000. 91. Assuming that Sands, Inc. uses straight-line depreciation, what is the amount of depreciation and interest expense that Sands should record for the year ended December 31, 2018?

a. $300,000 and $206,880 [($6,000,000 ÷ 10) x (1 ÷ 2)] = $300,000. ($6,000,000 - $828,000) × .04 = $206,880.

Mathis Co. at the end of 2017, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $ 1,200,000 Estimated litigation expense 3,000,000 Installment sales (2,400,000) Taxable income $ 1,800,000 The estimated litigation expense of $3,000,000 will be deductible in 2019 when it is expected to be paid. The gross profit from the installment sales will be realized in the amount of $1,200,000 in each of the next two years. The estimated liability for litigation is classified as noncurrent and the installment accounts receivable are classified as $1,200,000 current and $1,200,000 noncurrent. The income tax rate is 30% for all years. 55. The income tax expense is

a. $360,000. Income taxes payable = ($1,800,000 × 30%) = $540,000 Change in deferred tax liability = ($2,400,000 × 30%) = $720,000 Change in deferred tax asset = ($3,000,000 × 30%) = $900,000 $540,000 + $720,000 - $900,000 = $360,000 (or $1,200,000 x 30%.)

Hull Co. leased equipment to Riggs Company on May 1, 2018. At that time the collectibility of the minimum lease payments was not reasonably predictable. The lease expires on May 1, 2019. Riggs could have bought the equipment from Hull for $5,600,000 instead of leasing it. Hull's accounting records showed a book value for the equipment on May 1, 2018, of $4,900,000. Hull's depreciation on the equipment in 2018 was $630,000. During 2018, Riggs paid $1,260,000 in rentals to Hull for the 8-month period. Hull incurred maintenance and other related costs under the terms of the lease of $112,000 in 2018. After the lease with Riggs expires, Hull will lease the equipment to another company for two years. 83. The income before income taxes derived by Hull from this lease for the year ended December 31, 2018, should be

a. $518,000. $1,260,000 - $112,000 - $630,000 = $518,000.

Watson Corporation prepared the following reconciliation for its first year of operations: Pretax financial income for 2018 $2,700,000 Tax exempt interest (150,000) Originating temporary difference (450,000) Taxable income $2,100,000 The temporary difference will reverse evenly over the next two years at an enacted tax rate of 40%. The enacted tax rate for 2018 is 28%. What amount should be reported in its 2018 income statement as the current portion of its provision for income taxes?

a. $588,000 $2,100,000 × .28 = $588,000.

On January 1, 2018, Sauder Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Sauder to make annual payments of $200,000 at the beginning of each year for five years beginning on January 1, 2018 with the title passing to Sauder at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Sauder uses the straight-line method of depreciation for all of its fixed assets. Sauder accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $833,972 at an effective interest rate of 10%. In 2018, Sauder should record interest expense of

a. $63,397. ($833,972 - $200,000) × .10 = $63,397.

Ewing Company sells household furniture. Customers who purchase furniture on the installment basis make payments in equal monthly installments over a two-year period, with no down payment required. Ewing's gross profit on installment sales equals 40% of the selling price of the furniture. For financial accounting purposes, sales revenue is recognized at the time the sale is made. For income tax purposes, however, the installment method is used. There are no other book and income tax accounting differences, and Ewing's income tax rate is 30%. If Ewing's December 31, 2018, balance sheet includes a deferred tax liability of $900,000 arising from the difference between book and tax treatment of the installment sales, it should also include installment accounts receivable of

a. $7,500,000. $900,000 ÷ 30% = $3,000,000 temporary difference $3,000,000 ÷ 40% = $7,500,000.

Dunn, Inc. uses the accrual method of accounting for financial reporting purposes and appropriately uses the installment method of accounting for income tax purposes. Installment income of $3,000,000 will be collected in the following years when the enacted tax rates are: Collection of Income Enacted Tax Rates 2017 $300,000 35% 2018 600,000 30% 2019 900,000 30% 2020 1,200,000 25% The installment income is Dunn's only temporary difference. What amount should be included in the deferred income tax liability in Dunn's December 31, 2018 balance sheet?

a. $750,000 ($600,000 × 30%) + ($900,000 × 30%) + ($1,200,000 × 25%) = $750,000.

Lyons Company deducts insurance expense of $210,000 for tax purposes in 2018, but the expense is not yet recognized for accounting purposes. In 2019, 2020, and 2021, no insurance expense will be deducted for tax purposes, but $70,000 of insurance expense will be reported for accounting purposes in each of these years. Lyons Company has a tax rate of 40% and income taxes payable of $180,000 at the end of 2018. There were no deferred taxes at the beginning of 2018. 70. What is the amount of the deferred tax liability at the end of 2018?

a. $84,000 $210,000 × .40 = $84,000.

Torrey Co. manufactures equipment that is sold or leased. On December 31, 2018, Torrey leased equipment to Dalton for a five-year period ending December 31, 2023, at which date ownership of the leased asset will be transferred to Dalton. Equal payments under the lease are $1,100,000 (including $100,000 executory costs) and are due on December 31 of each year. The first payment was made on December 31, 2018. Collectibility of the remaining lease payments is reasonably assured, and Torrey has no material cost uncertainties. The normal sales price of the equipment is $3,850,000, and cost is $3,000,000. For the year ended December 31, 2018, what amount of income should Torrey realize from the lease transaction?

a. $850,000 $3,850,000 - $3,000,000 = $850,000.

Which of the following is false regarding accounting for deferred taxes under IFRS?

a. A deferred tax liability is classified as current or noncurrent based on the classification of the asset or liability to which it relates.

Rowen, Inc. had pre-tax accounting income of $2,700,000 and a tax rate of 40% in 2018, its first year of operations. During 2018 the company had the following transactions: Received rent from Jane, Co. for 2019 $ 96,000 Municipal bond income $120,000 Depreciation for tax purposes in excess of book depreciation $60,000 Installment sales profit to be taxed in 2019 $162,000 80. At the end of 2018, which of the following deferred tax accounts and balances exist at December 31, 2018? Account _ Balance

a. Account-Deferred tax asset Balance-$38,400 $96,000 × .40 = $38,400 Deferred tax asset.

A temporary difference arises when a revenue item is reported for tax purposes in a period After it is reported Before it is reported in financial income in financial income

a. After it is reported in financial income- Yes Before it is reported in financial income-Yes

Machinery was acquired at the beginning of the year. Depreciation recorded during the life of the machinery could result in Future Future Taxable Amounts Deductible Amount

a. Future Taxable Amounts- Yes Future Deductible Amounts- Yes

Hook Company leased equipment to Emley Company on July 1, 2017, for a one-year period expiring June 30, 2018, for $80,000 a month. On July 1, 2018, Hook leased this piece of equipment to Terry Company for a three-year period expiring June 30, 2021, for $100,000 a month. The original cost of the equipment was $6,400,000. The equipment, which has been continually on lease since July 1, 2013, is being depreciated on a straightline basis over an eight-year period with no salvage value. Assuming that both the lease to Emley and the lease to Terry are appropriately recorded as operating leases for accounting purposes, what is the amount of income (expense) before income taxes that each would record as a result of the above facts for the year ended December 31, 2018? Hook Emley Terry

a. Hook-$280,000 Emley-$(480,000) Terry-$(600,000) Hook: ($80,000 × 6) + ($100,000 × 6) - ($6,400,000 ÷ 8) = $280,000 Emley: ($80,000) × 6 = $(480,000) Terry: ($100,000) × 6 = $(600,000).

Which of the following temporary differences results in a deferred tax asset in the year the temporary difference originates? I. Accrual for product warranty liability. II. Subscriptions received in advance. III. Prepaid insurance expense.

a. I and II only.

Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2018 for the purpose of leasing a machine to be used in its manufacturing operations. The following data pertain to the agreement: (a) The term of the noncancelable lease is 3 years with no renewal option. Payments of $574,864 are due on January 1 of each year. (b) The fair value of the machine on January 1, 2018, is $1,600,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease. (c) Alt depreciates all machinery it owns on a straight-line basis. (d) Alt's incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8% implicit rate used by Yates. (e) Immediately after signing the lease, Yates finds out that Alt Corp. is the defendant in a suit which is sufficiently material to make collectibility of future lease payments doubtful. 78. From the viewpoint of Yates, what type of lease agreement exists?

a. Operating lease Fails to meet Group II requirements.

On January 1, 2018, Yancey, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Holt Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement. (a) The agreement requires equal rental payments at the beginning each year. (b) The fair value of the building on January 1, 2018 is $6,000,000; however, the book value to Holt is $4,950,000. (c) The building has an estimated economic life of 10 years, with no residual value. Yancey depreciates similar buildings on the straight-line method. (d) At the termination of the lease, the title to the building will be transferred to the lessee. (e) Yancey's incremental borrowing rate is 11% per year. Holt Warehouse Co. set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is known by Yancey, Inc. (f) The yearly rental payment includes $15,000 of executory costs related to taxes on the property. From the lessor's viewpoint, what type of lease is involved?

a. Sales-type lease Conceptual, FV exceeds cost.

Which of the following is a one of the criteria for recording a lease as a finance lease, under IFRS?

a. The lease term is for the major part of the economic life of the asset.

Based solely upon the following sets of circumstances indicated below, which set gives rise to a sales-type or direct-financing lease of a lessor? Transfers Ownership Contains Bargain Collectibility of Lease Any Important by End of Lease? Purchase Option? Payments Assured? Uncertainties?

a. Transfers Ownership by End of Lease?-No Contains Bargain Purchase Option?-Yes Collectibility of Lease Payments Assured?-Yes Any Important Uncertainties?-No

Companies are required to disclose the total of each of the following except

a. all deferred tax assets. b. all deferred tax liabilities. c. the total valuation allowance. d. All of these choices must be disclosed. Answer: D

A lessee with a capital lease containing a bargain purchase option should depreciate the leased asset over the

a. asset's remaining economic life.

Major reasons for disclosure of deferred income tax information is (are)

a. better assessment of quality of earnings. b. better predictions of future cash flows. c. predicting future cash flows for operating loss carryforwards. d. All of these answer choices are correct. Answer: D

Recognizing a valuation allowance for a deferred tax asset requires that a company

a. consider all positive and negative information in determining the need for a valuation allowance.

When lessors account for residual values related to leased assets, they

a. include the residual value because it is assumed the residual value will be realized.

An essential element of a lease is that the

a. lessor conveys less than his or her total interest in the property.

The methods of accounting for a lease by the lessee are

a. operating and capital lease methods.

An example of a permanent difference is

a. proceeds from life insurance on officers. b. interest expense on money borrowed to invest in municipal bonds. c. insurance expense for a life insurance policy on officers. d. All of these answers are correct as they are all examples of permanent differences. Answer: D

In a lease that is appropriately recorded as a direct-financing lease by the lessor, the unearned income

a. should be amortized over the period of the lease using the effective interest method.

A lessee had a ten-year capital lease requiring equal annual payments. The reduction of the lease liability in year 2 should equal

a. the current liability shown for the lease at the end of year 1.

At the beginning of 2018; Elephant, Inc. had a deferred tax asset of $20,000 and a deferred tax liability of $30,000. Pre-tax accounting income for 2018 was $1,500,000 and the enacted tax rate is 40%. The following items are included in Elephant's pre-tax income: Interest income from municipal bonds $120,000 Accrued warranty costs, estimated to be paid in 2019 $260,000 Operating loss carryforward $190,000 Installment sales profit, will be taxed in 2019 $130,000 Prepaid rent expense, will be used in 2019 $60,000 76. What is Elephant, Inc.'s taxable income for 2018?

b. $1,260,000 $1,500,000 - $120,000 + $260,000 - $190,000 - $130,000 - $60,000 = $1,260,000.

Kraft Company made the following journal entry in late 2018 for rent on property it leases to Danford Corporation. Cash 150,000 Unearned Rent Revenue 150,000 The payment represents rent for the years 2019 and 2020, the period covered by the lease. Kraft Company is a cash basis taxpayer. Kraft has income tax payable of $230,000 at the end of 2018, and its tax rate is 35%. 73. What amount of income tax expense should Kraft Company report at the end of 2018?

b. $177,500 $230,000 - ($150,000 × .35) = $177,500.

Fleming Company has the following cumulative taxable temporary differences: 12/31/18 12/31/17 $1,600,000 $2,250,000 The tax rate enacted for 2018 is 40%, while the tax rate enacted for future years is 30%. Taxable income for 2018 is $4,000,000 and there are no permanent differences. Fleming's pretax financial income for 2018 is:

b. $3,350,000 $4,000,000 - ($2,250,000 - $1,600,000) = $3,350,000.

Hopkins Co. at the end of 2017, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $3,000,000 Estimated litigation expense 4,000,000 Extra depreciation for taxes (6,000,000) Taxable income $ 1,000,000 The estimated litigation expense of $4,000,000 will be deductible in 2018 when it is expected to be paid. Use of the depreciable assets will result in taxable amounts of $2,000,000 in each of the next three years. The income tax rate is 30% for all years. 58. Income taxes payable is

b. $300,000. ($1,000,000 × 30%) = $300,000 or Income tax expense = ($3,000,000 × 30%) = $900,000 Change in deferred tax liability = ($4,000,000 × 30%) = $1,200,000 Change in deferred tax asset = ($6,000,000 × 30%) = $1,800,000 $900,000 + $1,200,000 - $1,800,000 = $300,000.

Gage Co. purchases land and constructs a service station and car wash for a total of $540,000. At January 2, 2018, when construction is completed, the facility and land on which it was constructed are sold to a major oil company for $600,000 and immediately leased from the oil company by Gage. Fair value of the land at time of the sale was $60,000. The lease is a 10-year, noncancelable lease. Gage uses straight-line depreciation for its other various business holdings. The economic life of the facility is 15 years with zero salvage value. Title to the facility and land will pass to Gage at termination of the lease. A partial amortization schedule for this lease is as follows: Payments Interest Amortization Balance Jan. 2, 2018 $600,000.00 Dec. 31, 2018 $97,646.71 $60,000.00 $37,646.71 562,353.29 Dec. 31, 2019 97,646.71 56,235.33 41,411.38 520,941.91 Dec. 31, 2020 97,646.71 52,094.19 45,552.52 475,389.39 The total lease-related income recognized by the lessee during 2019 is which of the following?

b. $4,000 ($600,000 - $540,000) ÷ 15 = $4,000.

Cross Company reported the following results for the year ended December 31, 2018, its first year of operations: 2018 Income (per books before income taxes) $ 2,000,000 Taxable income 3,200,000 The disparity between book income and taxable income is attributable to a temporary difference which will reverse in 2019. What should Cross record as a net deferred tax asset or liability for the year ended December 31, 2018, assuming that the enacted tax rates in effect are 40% in 2018 and 35% in 2019?

b. $420,000 deferred tax asset ($3,200,000 - $2,000,000) × 35% = $420,000 deferred tax asset.

On January 1, 2018, Sauder Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Sauder to make annual payments of $200,000 at the beginning of each year for five years beginning on January 1, 2018 with the title passing to Sauder at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Sauder uses the straight-line method of depreciation for all of its fixed assets. Sauder accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $833,972 at an effective interest rate of 10%. 63. In 2019, Sauder should record interest expense of

b. $49,737. [$633,972 - ($200,000 - $63,397)] × .10 = $49,737.

Haystack, Inc. manufactures machinery used in the mining industry. On January 2, 2018 it leased equipment with a cost of $480,000 to Silver Point Co. The 5-year lease calls for a 10% down payment and equal annual payments at the end of each year. The equipment has an expected useful life of 5 years. Silver Point's incremental borrowing rate is 10%, and it depreciates similar equipment using the double-declining balance method. The selling price of the equipment is $780,000, and the rate implicit in the lease is 8%, which is known to Silver Point Co. What is the amount of interest expense recorded by Silver Point Co. for the year ended December 31, 2018? PV Annuity Due PV Ordinary Annuity PV Single Sum 8%, 5 periods 4.31213 3.99271 .68508 10%, 5 periods 4.16986 3.79079 .62092

b. $56,160 ($780,000 × .90) ÷ 3.99271 = $175,820 $175,820 × 3.99271 = $701,998 $701,998 × .08 = $56,160.

Didde Corp. prepared the following reconciliation of income per books with income per tax return for the year ended December 31, 2018: Book income before income taxes $2,700,000 Add temporary difference Construction contract revenue which will reverse in 2019 240,000 Deduct temporary difference Depreciation expense which will reverse in equal amounts in each of the next four years (960,000) Taxable income $1,980,000 Didde's effective income tax rate is 34% for 2018. What amount should Didde report in its 2018 income statement as the current provision for income taxes?

b. $673,200 ($1,980,000 × 34%) = $673,200.

Ferguson Company has the following cumulative taxable temporary differences: 12/31/19 12/31/18 $3,600,000 $2,560,000 The tax rate enacted for 2019 is 40%, while the tax rate enacted for future years is 30%. Taxable income for 2019 is $6,400,000 and there are no permanent differences. Ferguson's pretax financial income for 2019 is

b. $7,440,000. $6,400,000 + ($3,600,000 - $2,560,000) = $7,440,000.

On June 30, 2018, Falk Co. sold equipment to an unaffiliated company for $2,000,000. The equipment had a book value of $1,080,000 and a remaining useful life of 10 years. That same day, Falk leased back the equipment at $12,000 per month for 5 years with no option to renew the lease or repurchase the equipment. Falk's rent expense for this equipment for the year ended December 31, 2018, should be

b. $72,000. $12,000 × 6 = $72,000.

A reconciliation of Gentry Company's pretax accounting income with its taxable income for 2018, its first year of operations, is as follows: Pretax accounting income $4,500,000 Excess tax depreciation (225,000) Taxable income $4,275,000 The excess tax depreciation will result in equal net taxable amounts in each of the next three years. Enacted tax rates are 40% in 2018, 35% in 2019 and 2020, and 30% in 2021. The total deferred tax liability to be reported on Gentry's balance sheet at December 31, 2018, is

b. $75,000. ($75,000 × 35%) + ($75,000 × 35%) + ($75,000 × 30%) = $75,000.

Metro Company, a dealer in machinery and equipment, leased equipment to Sands, Inc., on July 1, 2018. The lease is appropriately accounted for as a sales-type lease by Metro and as a capital lease by Sands. The lease is for a 10-year period (the useful life of the asset) expiring June 30, 2028. The first of 10 equal annual payments of $828,000 was made on July 1, 2018. Metro had purchased the equipment for $5,250,000 on January 1, 2018, and established a list selling price of $7,200,000 on the equipment. Assume that the present value at July 1, 2018, of the rent payments over the lease term discounted at 8% (the appropriate interest rate) was $6,000,000. 92. What is the amount of profit on the sale and the amount of interest revenue that Metro should record for the year ended December 31, 2018?

b. $750,000 and $206,880 $6,000,000 - $5,250,000 = $750,000. ($6,000,000 - $828,000) × .04 = $206,880.

At the beginning of 2018; Elephant, Inc. had a deferred tax asset of $20,000 and a deferred tax liability of $30,000. Pre-tax accounting income for 2018 was $1,500,000 and the enacted tax rate is 40%. The following items are included in Elephant's pre-tax income: Interest income from municipal bonds $120,000 Accrued warranty costs, estimated to be paid in 2019 $260,000 Operating loss carryforward $190,000 Installment sales profit, will be taxed in 2019 $130,000 Prepaid rent expense, will be used in 2019 $60,000 The ending balance in Elephant, Inc.'s deferred tax liability at December 31, 2018 is

b. $76,000 ($130,000 + $60,000) × .40 = $76,000.

Rowen, Inc. had pre-tax accounting income of $2,700,000 and a tax rate of 40% in 2018, its first year of operations. During 2018 the company had the following transactions: Received rent from Jane, Co. for 2019 $ 96,000 Municipal bond income $120,000 Depreciation for tax purposes in excess of book depreciation $60,000 Installment sales profit to be taxed in 2019 $162,000 79. For 2018, what is the amount of income taxes payable for Rowen, Inc?

b. $981,600 $2,700,000 + $96,000 - $120,000 - $60,000 - $162,000 = $2,454,000 $2,454,000 × .40 = $981,600.

Gage Co. purchases land and constructs a service station and car wash for a total of $540,000. At January 2, 2018, when construction is completed, the facility and land on which it was constructed are sold to a major oil company for $600,000 and immediately leased from the oil company by Gage. Fair value of the land at time of the sale was $60,000. The lease is a 10-year, noncancelable lease. Gage uses straight-line depreciation for its other various business holdings. The economic life of the facility is 15 years with zero salvage value. Title to the facility and land will pass to Gage at termination of the lease. A partial amortization schedule for this lease is as follows: Payments Interest Amortization Balance Jan. 2, 2018 $600,000.00 Dec. 31, 2018 $97,646.71 $60,000.00 $37,646.71 562,353.29 Dec. 31, 2019 97,646.71 56,235.33 41,411.38 520,941.91 Dec. 31, 2020 97,646.71 52,094.19 45,552.52 475,389.39 95. What is the discount rate implicit in the amortization schedule presented above?

b. 10% $60,000/$600,000=10% or $600,000/$97,646.71 =6.1446* *6.1446 = PV factor of ordinary annuity of $1 for 10 years at 10%.

At the beginning of 2018, Pitman Co. purchased an asset for $1,800,000 with an estimated useful life of 5 years and an estimated salvage value of $150,000. For financial reporting purposes the asset is being depreciated using the straight-line method; for tax purposes the double-decliningbalance method is being used. Pitman Co.'s tax rate is 40% for 2018 and all future years. 53. At the end of 2018, which of the following deferred tax accounts and balances is reported on Pitman's balance sheet?

b. Account- Deferred tax liability Balance-$156,000 ($1,470,000 - $1,080,000) × .40 = $156,000 Deferred tax liability.

Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2018 for the purpose of leasing a machine to be used in its manufacturing operations. The following data pertain to the agreement: (a) The term of the noncancelable lease is 3 years with no renewal option. Payments of $574,864 are due on January 1 of each year. (b) The fair value of the machine on January 1, 2018, is $1,600,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease. (c) Alt depreciates all machinery it owns on a straight-line basis. (d) Alt's incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8% implicit rate used by Yates. (e) Immediately after signing the lease, Yates finds out that Alt Corp. is the defendant in a suit which is sufficiently material to make collectibility of future lease payments doubtful. What type of lease is this from Alt Corporation's viewpoint?

b. Capital lease $574,864 × 2.73554 = $1,572,563; $1,572,563/$1,600,000=98%>90%

Palmer Co. had a deferred tax liability balance due to a temporary difference at the beginning of 2017 related to $1,500,000 of excess depreciation. In December of 2017, a new income tax act is signed into law that lowers the corporate rate from 40% to 35%, effective January 1, 2019. If taxable amounts related to the temporary difference are scheduled to be reversed by $750,000 for both 2018 and 2019, Palmer should increase or decrease deferred tax liability by what amount?

b. Decrease by $37,500 $750,000 × (.35 - .40) = $37,500 decrease.

On January 2, 2018, Gold Star Leasing Company leases equipment to Brick Co. with 5 equal annual payments of $160,000 each, payable beginning January 2, 2018. Brick Co. agrees to guarantee the $100,000 residual value of the asset at the end of the lease term. Brick's incremental borrowing rate is 10%, however it knows that Gold Star's implicit interest rate is 8%. What journal entry would Brick Co. make at January 2, 2018 to record the lease? PV Annuity Due PV Ordinary Annuity PV Single Sum 8%, 5 periods 4.31213 3.99271 .68508 10%, 5 periods 4.16986 3.79079 .62092

b. Leased Equipment 758,449 Cash 160,000 Lease Liability 598,449 ($160,000 × 4.31213) + ($100,000 × .68508) = $758,449.

Which of the following are temporary differences that are normally classified as expenses or losses that are deductible after they are recognized in financial income?

b. Product warranty liabilities.

Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2018 for the purpose of leasing a machine to be used in its manufacturing operations. The following data pertain to the agreement: (a) The term of the noncancelable lease is 3 years with no renewal option. Payments of $574,864 are due on January 1 of each year. (b) The fair value of the machine on January 1, 2018, is $1,600,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease. (c) Alt depreciates all machinery it owns on a straight-line basis. (d) Alt's incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8% implicit rate used by Yates. (e) Immediately after signing the lease, Yates finds out that Alt Corp. is the defendant in a suit which is sufficiently material to make collectibility of future lease payments doubtful. 76. If Alt accounts for the lease as an operating lease, what expenses will be recorded as a consequence of the lease during the fiscal year ended December 31, 2018?

b. Rent Expense

What impact does a bargain purchase option have on the present value of the minimum lease payments computed by the lessee?

b. The lessee must increase the present value of the minimum lease payments by the present value of the option price.

A lessor with a sales-type lease involving an unguaranteed residual value available to the lessor at the end of the lease term will report sales revenue in the period of inception of the lease at which of the following amounts?

b. The present value of the minimum lease payments.

If none of the four leasing criteria are satisfied in a sale-leaseback transaction, which of the following statements is incorrect?

b. The purchaser-lessor records a gain.

A company records an unrealized loss on trading securities. This would result in what type of difference and in what type of deferred income tax? Type of Difference Deferred Tax

b. Type of Difference-Temporary Deferred Tax-Asset

At the December 31, 2017 balance sheet date, Unruh Corporation reports an accrued receivable for financial reporting purposes but not for tax purposes. When this asset is recovered in 2018, a future taxable amount will occur and

b. Unruh will record a decrease in a deferred tax liability in 2018.

Accounting for income taxes can result in the reporting of deferred taxes as

b. a non current liability.

Deferred taxes should be presented on the balance sheet

b. as a noncurrent amount.

From the lessee's perspective, in the earlier years of a lease, the use of the

b. capital method will cause debt to increase, compared to the operating method.

Taxable income of a corporation

b. differs from accounting income because companies use the full accrual method for financial reporting but use the modified cash basis for tax reporting.

The deferred tax expense is the

b. increase in balance of deferred tax liability minus the increase in balance of deferred tax asset.

The amount to be recorded as the cost of an asset under capital lease is equal to the

b. present value of the minimum lease payments or the fair value of the asset, whichever is lower

Recognition of tax benefits in the loss year due to a loss carryforward requires

b. the establishment of a deferred tax asset.

Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2018 for the purpose of leasing a machine to be used in its manufacturing operations. The following data pertain to the agreement: (a) The term of the noncancelable lease is 3 years with no renewal option. Payments of $574,864 are due on January 1 of each year. (b) The fair value of the machine on January 1, 2018, is $1,600,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease. (c) Alt depreciates all machinery it owns on a straight-line basis. (d) Alt's incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8% implicit rate used by Yates. (e) Immediately after signing the lease, Yates finds out that Alt Corp. is the defendant in a suit which is sufficiently material to make collectibility of future lease payments doubtful. If Yates records this lease as a direct-financing lease, what amount would be recorded as Lease Receivable at the inception of the lease?

c. $1,600,000 Fair value = $1,600,000.

Hopkins Co. at the end of 2017, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $3,000,000 Estimated litigation expense 4,000,000 Extra depreciation for taxes (6,000,000) Taxable income $ 1,000,000 The estimated litigation expense of $4,000,000 will be deductible in 2018 when it is expected to be paid. Use of the depreciable assets will result in taxable amounts of $2,000,000 in each of the next three years. The income tax rate is 30% for all years. 60. The amount of deferred tax liability to be recognized is

c. $1,800,000 ($6,000,000 × 30%) = $1,800,000.

For calendar year 2018, Kane Corp. reported depreciation of $1,600,000 in its income statement. On its 2018 income tax return, Kane reported depreciation of $2,400,000. Kane's income statement also included $300,000 accrued warranty expense that will be deducted for tax purposes when paid. Kane's enacted tax rates are 30% for 2018 and 2019, and 24% for 2020 and 2021. The depreciation difference and warranty expense will reverse over the next three years as follows: Depreciation Difference Warranty Expense 2019 $320,000 $ 60,000 2020 280,000 100,000 2021 200,000 140,000 $800,000 $300,000 These were Kane's only temporary differences. In Kane's 2018 income statement, the deferred portion of its provision for income taxes should be

c. $135,600. ($320,000 - $60,000) × 30% = $78,000; ($280,000 - $100,000) × 24% = $43,200; ($200,000 - $140,000) × 24% = $14,400; $78,000 + $43,200 + $14,400 = $135,600.

On January 2, 2018, Hernandez, Inc. signed a ten-year noncancelable lease for a heavy duty drill press. The lease stipulated annual payments of $300,000 starting at the beginning of the first year, with title passing to Hernandez at the expiration of the lease. Hernandez treated this transaction as a capital lease. The drill press has an estimated useful life of 15 years, with no salvage value. Hernandez uses straight-line depreciation for all of its plant assets. Aggregate lease payments were determined to have a present value of $1,800,000, based on implicit interest of 10%. 104. In its 2018 income statement, what amount of interest expense should Hernandez report from this lease transaction?

c. $150,000 ($1,800,000 − $300,000)× .10 = $150,000.

Pye Company leased equipment to the Polan Company on July 1, 2018, for a ten-year period expiring June 30, 2028. Equal annual payments under the lease are $240,000 and are due on July 1 of each year. The first payment was made on July 1, 2018. The rate of interest contemplated by Pye and Polan is 9%. The cash selling price of the equipment is $1,680,000 and the cost of the equipment on Pye's accounting records was $1,488,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Pye, what is the amount of profit on the sale and the interest revenue that Pye would record for the year ended December 31, 2018?

c. $192,000 and $64,800 $1,680,000 - $1,488,000 = $192,000; ($1,680,000 - $240,000) × .09 × 6/12 = $64,800.

On December 31, 2018, Lang Corporation leased a ship from Fort Company for an eightyear period expiring December 30, 2026. Equal annual payments of $500,000 are due on December 31 of each year, beginning with December 31, 2018. The lease is properly classified as a capital lease on Lang 's books. The present value at December 31, 2018 of the eight lease payments over the lease term discounted at 10% is $2,934,213. Assuming all payments are made on time, the amount that should be reported by Lang Corporation as the total obligation under capital leases on its December 31, 2019 balance sheet is

c. $2,177,634. $2,934,213 - $500,000 = $2,434,213 × .10 = $243,421 $2,434,213 - ($500,000 - $243,421) = $2,177,634.

Kraft Company made the following journal entry in late 2018 for rent on property it leases to Danford Corporation. Cash 150,000 Unearned Rent Revenue 150,000 The payment represents rent for the years 2019 and 2020, the period covered by the lease. Kraft Company is a cash basis taxpayer. Kraft has income tax payable of $230,000 at the end of 2018, and its tax rate is 35%. 74. Assuming the income taxes payable at the end of 2019 is $255,000, what amount of income tax expense would Kraft Company record for 2019?

c. $281,250 $255,000 + ($75,000 × .35) = $281,250.

Duncan Inc. uses the accrual method of accounting for financial reporting purposes and appropriately uses the installment method of accounting for income tax purposes. Profits of $1,200,000 recognized for books in 2017 will be collected in the following years: Collection of Profits 2018 $200,000 2019 $400,000 2020 $600,000 The enacted tax rates are: 40% for 2017, 35% for 2018, and 30% for 2019 and 2020. Taxable income is expected in all future years. What amount should be included in the December 31, 2017, balance sheet for the deferred tax liability related to the above temporary difference?

c. $370,000 ($200,000 × .35) + [($400,000 + $600,000) × .30] = $370,000.

Geary Co. leased a machine to Dains Co. Assume the lease payments were made on the basis that the residual value was guaranteed and Geary gets to recognize all the profits. At the end of the lease term, before the lessee transfers the asset to the lessor, the leased asset and obligation accounts have the following balances: Leased equipment $400,000 Less accumulated depreciation--capital lease 384,000 $ 16,000 Interest payable $ 1,520 Lease liability 14,480 $16,000 If, at the end of the lease, the fair value of the residual value is $11,800, what gain or loss should Geary record?

c. $4,200 loss $11,800 - $16,000 = ($4,200).

Haystack, Inc. manufactures machinery used in the mining industry. On January 2, 2018 it leased equipment with a cost of $480,000 to Silver Point Co. The 5-year lease calls for a 10% down payment and equal annual payments of $219,777 at the end of each year. The equipment has an expected useful life of 5 years. Silver Point's incremental borrowing rate is 10%, and it depreciates similar equipment using the double-declining balance method. The selling price of the equipment is $780,000, and the rate implicit in the lease is 8%, which is known to Silver Point Co. What is the book value of the leased asset at December 31, 2018?

c. $468,000 $780,000 - ($780,000 × .40) = $468,000

Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2018 for the purpose of leasing a machine to be used in its manufacturing operations. The following data pertain to the agreement: (a) The term of the noncancelable lease is 3 years with no renewal option. Payments of $574,864 are due on January 1 of each year. (b) The fair value of the machine on January 1, 2018, is $1,600,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease. (c) Alt depreciates all machinery it owns on a straight-line basis. (d) Alt's incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8% implicit rate used by Yates. (e) Immediately after signing the lease, Yates finds out that Alt Corp. is the defendant in a suit which is sufficiently material to make collectibility of future lease payments doubtful. If the present value of the future lease payments is $1,600,000 at January 1, 2018, what is the amount of the reduction in the lease liability for Alt Corp. in the second full year of the lease if Alt Corp. accounts for the lease as a capital lease? (Rounded to the nearest dollar.)

c. $472,350 $1,600,000 -$574,864 = $1,025,136. $574,864 - ($1,025,136 × .1) = $472,350.

Roman Company leased equipment from Koenig Company on July 1, 2018, for an eightyear period expiring June 30, 2026. Equal annual payments under the lease are $800,000 and are due on July 1 of each year. The first payment was made on July 1, 2018. The rate of interest contemplated by Roman and Koenig is 8%. The cash selling price of the equipment is $4,965,000 and the cost of the equipment on Koenig's accounting records was $4,400,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Koenig, what is the amount of profit on the sale and the interest income that Koenig would record for the year ended December 31, 2018?

c. $565,000 and $166,600 $4,965,000 - $4,400,000 = $565,000. ($4,965,000 - $800,000) × .04 = $166,600.

Mitchell Corporation prepared the following reconciliation for its first year of operations: Pretax financial income for 2018 $ 1,800,000 Tax exempt interest (150,000) Originating temporary difference (350,000) Taxable income $1,300,000 The temporary difference will reverse evenly over the next two years at an enacted tax rate of 40%. The enacted tax rate for 2018 is 35%. 67. In Mitchell's 2018 income statement, what amount should be reported for total income tax expense?

c. $595,000 ($1,300,000 × .35) + ($350,000 × .40) = $595,000.

On January 1, 2018, Yancey, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Holt Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement. (a) The agreement requires equal rental payments at the beginning each year. (b) The fair value of the building on January 1, 2018 is $6,000,000; however, the book value to Holt is $4,950,000. (c) The building has an estimated economic life of 10 years, with no residual value. Yancey depreciates similar buildings on the straight-line method. (d) At the termination of the lease, the title to the building will be transferred to the lessee. (e) Yancey's incremental borrowing rate is 11% per year. Holt Warehouse Co. set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is known by Yancey, Inc. (f) The yearly rental payment includes $15,000 of executory costs related to taxes on the property. Yancey, Inc. would record depreciation expense on this storage building in 2018 of (Rounded to the nearest dollar.)

c. $600,000. $6,000,000 ÷ 10 = $600,000.

Wright Co., organized on January 2, 2018, had pretax accounting income of $960,000 and taxable income of $3,120,000 for the year ended December 31, 2018. The only temporary difference is accrued product warranty costs which are expected to be paid as follows: 2019 $720,000 2020 360,000 2021 360,000 2022 720,000 The enacted income tax rates are 35% for 2018, 30% for 2019 through 2021, and 25% for 2022. If Wright expects taxable income in future years, the deferred tax asset in Wright's December 31, 2018 balance sheet should be

c. $612,000. ($720,000 + $360,000 + $360,000) × 30% = $432,000; $720,000 × 25% = $180,000; $432,000 + $180,000 = $612,000.

Harter Company leased machinery to Stine Company on July 1, 2018, for a ten-year period expiring June 30, 2028. Equal annual payments under the lease are $250,000 and are due on July 1 of each year. The first payment was made on July 1, 2018. The rate of interest used by Harter and Stine is 9%. The cash selling price of the machinery is $1,750,000 and the cost of the machinery on Harter's accounting records was $1,550,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Harter, what amount of interest revenue would Harter record for the year ended December 31, 2018?

c. $67,500 ($1,750,000 - $250,000) × .09 × 6/12 = $67,500.

On January 1, 2018, Gore, Inc. purchased a machine for $2,250,000 which will be depreciated $225,000 per year for financial statement reporting purposes. For income tax reporting, Gore elected to expense $250,000 and to use straight-line depreciation which will allow a cost recovery deduction of $200,000 for 2018. Assume a present and future enacted income tax rate of 30%. What amount should be added to Gore's deferred income tax liability for this temporary difference at December 31, 2018?

c. $67,500 ($250,000 + $200,000 - $225,000) × 30% = $67,500.

Pisa, Inc. leased equipment from Tower Company under a four-year lease requiring equal annual payments of $344,152, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4-year useful life and no salvage value. Pisa, Inc.'s incremental borrowing rate is 10% and the rate implicit in the lease (which is known by Pisa, Inc.) is 8%. Assuming that this lease is properly classified as a capital lease, what is the amount of interest expense recorded by Pisa, Inc. in the first year of the asset's life? PV Annuity Due PV Ordinary Annuity 8%, 4 periods 3.57710 3.31213 10%, 4 periods 3.48685 3.16986

c. $70,953 $344,152 × 3.57710 = $1,231,066 ($1,231,066 - $344,152) × .08 = $70,953.

Mathis Co. at the end of 2017, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $ 1,200,000 Estimated litigation expense 3,000,000 Installment sales (2,400,000) Taxable income $ 1,800,000 The estimated litigation expense of $3,000,000 will be deductible in 2019 when it is expected to be paid. The gross profit from the installment sales will be realized in the amount of $1,200,000 in each of the next two years. The estimated liability for litigation is classified as noncurrent and the installment accounts receivable are classified as $1,200,000 current and $1,200,000 noncurrent. The income tax rate is 30% for all years. 57. The deferred tax liability to be recognized is

c. $720,000. ($2,400,000 × 30%) = $720,000.

Metcalf Company leases a machine from Vollmer Corp. under an agreement which meets the criteria to be a capital lease for Metcalf. The six-year lease requires payment of $170,000 at the beginning of each year, including $25,000 per year for maintenance, insurance, and taxes. The incremental borrowing rate for the lessee is 10%; the lessor's implicit rate is 8% and is known by the lessee. The present value of an annuity due of 1 for six years at 10% is 4.79079. The present value of an annuity due of 1 for six years at 8% is 4.99271. Metcalf should record the leased asset at

c. $723,943. ($170,000 - $25,000) × 4.99271 = $723,943.

On January 1, 2018, Yancey, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Holt Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement. (a) The agreement requires equal rental payments at the beginning each year. (b) The fair value of the building on January 1, 2018 is $6,000,000; however, the book value to Holt is $4,950,000. (c) The building has an estimated economic life of 10 years, with no residual value. Yancey depreciates similar buildings on the straight-line method. (d) At the termination of the lease, the title to the building will be transferred to the lessee. (e) Yancey's incremental borrowing rate is 11% per year. Holt Warehouse Co. set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is known by Yancey, Inc. (f) The yearly rental payment includes $15,000 of executory costs related to taxes on the property. 54. What is the amount of the minimum annual lease payment? (Rounded to the nearest dollar.)

c. $887,703 $6,000,000 ÷ 6.75902 = $887,703 (PV of Annuity Due Table).

Operating income and tax rates for C.J. Company's first three years of operations were as follows: Income _ Enacted tax rate 2017 $400,000 35% 2018 ($1,000,000) 30% 2019 $1,680,000 40% 94. Assuming that C.J. Company opts only to carryforward its 2018 NOL, what is the amount of deferred tax asset or liability that C.J. Company would report on its December 31, 2018 balance sheet? Amount _ Deferred tax asset or liability

c. Amount- $400,000 Deferred tax asset or liability- Deferred tax asset $1,000,000 × .40 = $400,000.

At the beginning of 2018, Pitman Co. purchased an asset for $1,800,000 with an estimated useful life of 5 years and an estimated salvage value of $150,000. For financial reporting purposes the asset is being depreciated using the straight-line method; for tax purposes the double-decliningbalance method is being used. Pitman Co.'s tax rate is 40% for 2018 and all future years. 52. At the end of 2018, what are the book basis and the tax basis of the asset?

c. Book basis- $1,470,000 Tax basis-$1,080,000 $1,800,000 - [($1,800,000 - $150,000) ÷ 5)] = $1,470,000; $1,800,000 - ($1,800,000 × 1 /5 × 2) = $1,080,000.

On January 1, 2018, Yancey, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Holt Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement. (a) The agreement requires equal rental payments at the beginning each year. (b) The fair value of the building on January 1, 2018 is $6,000,000; however, the book value to Holt is $4,950,000. (c) The building has an estimated economic life of 10 years, with no residual value. Yancey depreciates similar buildings on the straight-line method. (d) At the termination of the lease, the title to the building will be transferred to the lessee. (e) Yancey's incremental borrowing rate is 11% per year. Holt Warehouse Co. set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is known by Yancey, Inc. (f) The yearly rental payment includes $15,000 of executory costs related to taxes on the property. From the lessee's viewpoint, what type of lease exists in this case?

c. Capital lease

Gage Co. purchases land and constructs a service station and car wash for a total of $540,000. At January 2, 2018, when construction is completed, the facility and land on which it was constructed are sold to a major oil company for $600,000 and immediately leased from the oil company by Gage. Fair value of the land at time of the sale was $60,000. The lease is a 10-year, noncancelable lease. Gage uses straight-line depreciation for its other various business holdings. The economic life of the facility is 15 years with zero salvage value. Title to the facility and land will pass to Gage at termination of the lease. A partial amortization schedule for this lease is as follows: Payments Interest Amortization Balance Jan. 2, 2018 $600,000.00 Dec. 31, 2018 $97,646.71 $60,000.00 $37,646.71 562,353.29 Dec. 31, 2019 97,646.71 56,235.33 41,411.38 520,941.91 Dec. 31, 2020 97,646.71 52,094.19 45,552.52 475,389.39 94. From the viewpoint of the lessor, what type of lease is involved above?

c. Direct-financing lease

Which of the following statement is true?

c. IFRS is more general in its provisions for determining if a lease arrangement transfers the risks and rewards of ownership.

Lease A does not contain a bargain purchase option, but the lease term is equal to 90 percent of the estimated economic life of the leased property. Lease B does not transfer ownership of the property to the lessee by the end of the lease term, but the lease term is equal to 75 percent of the estimated economic life of the leased property. How should the lessee classify these leases? Lease A Lease B

c. Lease A- Capital lease Lease B-Capital lease

On January 2, 2018, Gold Star Leasing Company leases equipment to Brick Co. with 5 equal annual payments of $160,000 each, payable beginning January 2, 2018. Brick Co. agrees to guarantee the $100,000 residual value of the asset at the end of the lease term. Brick's incremental borrowing rate is 10%, however it knows that Gold Star's implicit interest rate is 8%. What journal entry would Brick Co. make at January 1, 2019 to record the second lease payment? PV Annuity Due PV Ordinary Annuity PV Single Sum 8%, 5 periods 4.31213 3.99271 .68508 10%, 5 periods 4.16986 3.79079 .62092

c. Lease Liability 112,124 Interest Payable 47,876 Cash 160,000 ($160,000 × 4.31213) + ($100,000 × .68508) = $758,449 ($758,449 − $160,000) × .08 = $47,876 Interest $160,000 −$47,876 = $112,124.

Taxable income of a corporation differs from pretax financial income because of Permanent Differences Temporary Differences

c. Permanent Differences-Yes Temporary Differences-Yes

Which of the following is a correct statement of one of the capitalization criteria?

c. The lease term is equal to or more than 75% of the estimated economic life of the leased property.

To avoid leased asset capitalization, companies can devise lease agreements that fail to satisfy any of the four leasing criteria. Which of the following is not one of the ways to accomplish this goal?

c. Write in a bargain purchase option.

Stuart Corporation's taxable income differed from its accounting income computed for this past year. An item that would create a permanent difference in accounting and taxable incomes for Stuart would be

c. a fine resulting from violations of OSHA regulations.

While only certain leases are currently accounted for as a sale or purchase, there is theoretical justification for considering all leases to be sales or purchases. The principal reason that supports this idea is that

c. a lease reflects the purchase or sale of a quantifiable right to the use of property.

The initial direct costs of leasing

c. are expensed in the period of the sale under a sales-type lease.

The Lease Liability account should be disclosed as

c. current portions in current liabilities and the remainder in noncurrent liabilities.

On January 1, 2018, Dean Corporation signed a ten-year noncancelable lease for certain machinery. The terms of the lease called for Dean to make annual payments of $220,000 at the end of each year for ten years with the title passing to Dean at the end of this period. The machinery has an estimated useful life of 15 years and no salvage value. Dean uses the straight-line method of depreciation for all of its fixed assets. Dean accordingly accounted for this lease transaction as a capital lease. The lease payments were determined to have a present value of $1,342,016 at an effective interest rate of 8%. With respect to this capitalized lease, Dean should record for 2018

c. interest expense of $107,361 and depreciation expense of $89,468. $1,342,016 × .08 = $107,361, $1,342,016 ÷ 15 = $89,468.

On January 1, 2018, Ogleby Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Ogleby to make annual payments of $180,000 at the beginning of each year for five years with title passing to Ogleby at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Ogleby uses the straight-line method of depreciation for all of its fixed assets. Ogleby accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $750,578 at an effective interest rate of 10%. 66. With respect to this capitalized lease, for 2019 Ogleby should record

c. interest expense of $44,764 and depreciation expense of $107,225. [$750,578 − $180,000 - ($180,000 - $57,058)] × .10 = $44,764.

On January 1, 2018, Ogleby Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Ogleby to make annual payments of $180,000 at the beginning of each year for five years with title passing to Ogleby at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Ogleby uses the straight-line method of depreciation for all of its fixed assets. Ogleby accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $750,578 at an effective interest rate of 10%. 65. With respect to this capitalized lease, for 2018 Ogleby should record

c. interest expense of $57,058 and depreciation expense of $107,225. ($750,578 − $180,000) × .10 = $57,058; ($750,578 - 0) ÷ 7 = $107,225.

Assuming a 40% statutory tax rate applies to all years involved, which of the following situations will give rise to reporting a deferred tax liability on the balance sheet? I. A revenue is deferred for financial reporting purposes but not for tax purposes. II. A revenue is deferred for tax purposes but not for financial reporting purposes. III. An expense is deferred for financial reporting purposes but not for tax purposes. IV. An expense is deferred for tax purposes but not for financial reporting purposes.

c. items II and III only

All of the following are procedures for the computation of deferred income taxes except to

c. measure the total deferred tax liability for deductible temporary differences.

The primary difference between a direct-financing lease and a sales-type lease is the

c. recognition of the manufacturer's or dealer's profit at (or loss) the inception of the lease.

When a change in the tax rate is enacted into law, its effect on existing deferred income tax accounts should be

c. reported as an adjustment to income tax expense in the period of change.

In a lease that is recorded as a sales-type lease by the lessor, interest revenue

c. should be recognized over the period of the lease using the effective interest method.

Tax rates other than the current tax rate may be used to calculate the deferred income tax amount on the balance sheet if

c. the future tax rates have been enacted into law.

In order to properly record a direct-financing lease, the lessor needs to know how to calculate the lease receivable. The lease receivable in a direct-financing lease is best defined as

c. the present value of minimum lease payments.

In computing the present value of the minimum lease payments, the lessee should

c. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is lower, assuming that the implicit rate is known to the lessee.

On January 1, 2018, Piper Corp. purchased 40% of the voting common stock of Betz, Inc. and appropriately accounts for its investment by the equity method. During 2018, Betz reported earnings of $1,200,000 and paid dividends of $400,000. Piper assumes that all of Betz's undistributed earnings will be distributed as dividends in future periods when the enacted tax rate will be 30%. Ignore the dividend-received deduction. Piper's current enacted income tax rate is 25%. The increase in Piper's deferred income tax liability for this temporary difference is

d. $ 96,000. ($1,200,000 - $400,000) × 40% = $320,000; $320,000 × 30% = $96,000.

Wilcox Corporation reported the following results for its first three years of operation: 2017 income (before income taxes) $ 300,000 2018 loss (before income taxes) (2,700,000) 2019 income (before income taxes) 3,000,000 There were no permanent or temporary differences during these three years. Assume a corporate tax rate of 30% for 2017 and 2018, and 40% for 2019. 89. Assuming that Wilcox elects to use the carryback provision, what income (loss) is reported in 2018? (Assume that any deferred tax asset recognized is more likely than not to be realized.)

d. $(1,650,000) ($300,000 × 30%) = $90,000; $2,400,000 × 40% = $960,000; ($2,700,000 - $90,000 - $960,000) = $1,650,000.

On December 31, 2018, Haden Corp. sold a machine to Ryan and simultaneously leased it back for one year. Pertinent information at this date follows: Sales price $1,080,000 Carrying amount 990,000 Present value of reasonable lease rentals ($9,000 for 12 months @ 12%) 102,000 Estimated remaining useful life 12 years In Haden's December 31, 2018 balance sheet, the deferred profit from the sale of this machine should be

d. $0. $102,000/$1,080,000= 9.44%, < 10% of FV of asset ∴ it is a minor leaseback.

In 2018, Krause Company accrued, for financial statement reporting, estimated losses on disposal of unused plant facilities of $3,600,000. The facilities were sold in March 2019 and a $3,600,000 loss was recognized for tax purposes. Also in 2018, Krause paid $150,000 in premiums for a two-year life insurance policy in which the company was the beneficiary. Assuming that the enacted tax rate is 30% in both 2018 and 2019, and that Krause paid $1,170,000 in income taxes in 2018, the amount reported as net deferred income taxes on Krause's balance sheet at December 31, 2018, should be a

d. $1,080,000 asset. ($3,600,000 × 30%) = $1,080,000.

Hopkins Co. at the end of 2017, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $3,000,000 Estimated litigation expense 4,000,000 Extra depreciation for taxes (6,000,000) Taxable income $ 1,000,000 The estimated litigation expense of $4,000,000 will be deductible in 2018 when it is expected to be paid. Use of the depreciable assets will result in taxable amounts of $2,000,000 in each of the next three years. The income tax rate is 30% for all years. The deferred tax asset to be recognized is

d. $1,200,000. ($4,000,000 × 30%) = $1,200,000.

Hull Co. leased equipment to Riggs Company on May 1, 2018. At that time the collectibility of the minimum lease payments was not reasonably predictable. The lease expires on May 1, 2019. Riggs could have bought the equipment from Hull for $5,600,000 instead of leasing it. Hull's accounting records showed a book value for the equipment on May 1, 2018, of $4,900,000. Hull's depreciation on the equipment in 2018 was $630,000. During 2018, Riggs paid $1,260,000 in rentals to Hull for the 8-month period. Hull incurred maintenance and other related costs under the terms of the lease of $112,000 in 2018. After the lease with Riggs expires, Hull will lease the equipment to another company for two years. 82. Ignoring income taxes, the amount of expense incurred by Riggs from this lease for the year ended December 31, 2018, should be

d. $1,260,000. $1,260,000.

Emporia Corporation is a lessee with a capital lease. The asset is recorded at $900,000 and has an economic life of 8 years. The lease term is 5 years. The asset is expected to have a fair value of $300,000 at the end of 5 years, and a fair value of $100,000 at the end of 8 years. The lease agreement provides for the transfer of title of the asset to the lessee at the end of the lease term. What amount of depreciation expense would the lessee record for the first year of the lease?

d. $100,000 ($900,000 - $100,000) ÷ 8 = $100,000.

On January 2, 2018, Hernandez, Inc. signed a ten-year noncancelable lease for a heavy duty drill press. The lease stipulated annual payments of $300,000 starting at the beginning of the first year, with title passing to Hernandez at the expiration of the lease. Hernandez treated this transaction as a capital lease. The drill press has an estimated useful life of 15 years, with no salvage value. Hernandez uses straight-line depreciation for all of its plant assets. Aggregate lease payments were determined to have a present value of $1,800,000, based on implicit interest of 10%. 105. In its 2018 income statement, what amount of depreciation expense should Hernandez report from this lease transaction?

d. $120,000 $1,800,000 ÷ 15 = $120,000.

On December 31, 2018, Kuhn Corporation leased a plane from Bell Company for an seven-year period expiring December 31, 2025. Equal annual payments of $450,000 are due on December 31 of each year, beginning with December 31, 2018. The lease is properly classified as a capital lease on Kuhn's books. The present value at December 31, 2018 of the eight lease payments over the lease term discounted at 10% is $2,640,792. Assuming the first payment is made on time, the amount that should be reported by Kuhn Corporation as the lease liability on its December 31, 2018 balance sheet is

d. $2,190,792. $2,640,792 - $450,000 = $2,190,792.

Lyons Company deducts insurance expense of $210,000 for tax purposes in 2018, but the expense is not yet recognized for accounting purposes. In 2019, 2020, and 2021, no insurance expense will be deducted for tax purposes, but $70,000 of insurance expense will be reported for accounting purposes in each of these years. Lyons Company has a tax rate of 40% and income taxes payable of $180,000 at the end of 2018. There were no deferred taxes at the beginning of 2018. 72. Assuming that income taxes payable for 2019 is $240,000, the income tax expense for 2019 would be what amount?

d. $212,000 $240,000 - ($70,000 × .40) = $212,000.

Eckert Corporation's partial income statement after its first year of operations is as follows: Income before income taxes $3,750,000 Income tax expense Current $1,035,000 Deferred 90,000 1,125,000 Net income $2,625,000 Eckert uses the straight-line method of depreciation for financial reporting purposes and accelerated depreciation for tax purposes. The amount charged to depreciation expense on its books this year was $2,800,000. No other differences existed between book income and taxable income except for the amount of depreciation. Assuming a 30% tax rate, what amount was deducted for depreciation on the corporation's tax return for the current year?

d. $3,100,000 (30% × Temporary Difference) = $90,000; Temporary Difference = ($90,000 ÷ 30%) = $300,000; $2,800,000 + $300,000 = $3,100,000.

On December 31, 2018, Harris Co. leased a machine from Catt, Inc. for a five-year period. Equal annual payments under the lease are $2,100,000 (including $100,000 annual executory costs) and are due on December 31 of each year. The first payment was made on December 31, 2018, and the second payment was made on December 31, 2019. The five lease payments are discounted at 10% over the lease term. The present value of minimum lease payments at the inception of the lease and before the first annual payment was $8,340,000. The lease is appropriately accounted for as a capital lease by Harris. In its December 31, 2019 balance sheet, Harris should report a lease liability of

d. $4,974,000. $8,340,000 - $2,100,000 + $100,000 = $6,340,000 (2018). $6,340,000 - [$2,000,000 - ($6,340,000 × .10)] = $4,974,000 (2019)

Operating income and tax rates for C.J. Company's first three years of operations were as follows: Income _ Enacted tax rate 2017 $400,000 35% 2018 ($1,000,000) 30% 2019 $1,680,000 40% 93. Assuming that C.J. Company opts to carryback its 2018 NOL, what is the amount of income taxes payable at December 31, 2019?

d. $432,000 [$1,680,000 - ($1,000,000 - $400,000)] × .40 = $432,000.

Gage Co. purchases land and constructs a service station and car wash for a total of $540,000. At January 2, 2018, when construction is completed, the facility and land on which it was constructed are sold to a major oil company for $600,000 and immediately leased from the oil company by Gage. Fair value of the land at time of the sale was $60,000. The lease is a 10-year, noncancelable lease. Gage uses straight-line depreciation for its other various business holdings. The economic life of the facility is 15 years with zero salvage value. Title to the facility and land will pass to Gage at termination of the lease. A partial amortization schedule for this lease is as follows: Payments Interest Amortization Balance Jan. 2, 2018 $600,000.00 Dec. 31, 2018 $97,646.71 $60,000.00 $37,646.71 562,353.29 Dec. 31, 2019 97,646.71 56,235.33 41,411.38 520,941.91 Dec. 31, 2020 97,646.71 52,094.19 45,552.52 475,389.39 97. What is the amount of the lessee's liability to the lessor after the December 31, 2020 payment?

d. $475,389 $475,389 (See amortization table.)

The following information is available for Kessler Company after its first year of operations: Income before taxes $250,000 Federal income tax payable $104,000 Deferred income tax (4,000) Income tax expense 100,000 Net income $150,000 Kessler estimates its annual warranty expense as a percentage of sales. The amount charged to warranty expense on its books was $95,000. Assuming a 40% income tax rate, what amount was actually paid this year for warranty claims?

d. $85,000 $95,000 - ($4,000 ÷ .40) = $85,000.

Mathis Co. at the end of 2017, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $ 1,200,000 Estimated litigation expense 3,000,000 Installment sales (2,400,000) Taxable income $ 1,800,000 The estimated litigation expense of $3,000,000 will be deductible in 2019 when it is expected to be paid. The gross profit from the installment sales will be realized in the amount of $1,200,000 in each of the next two years. The estimated liability for litigation is classified as noncurrent and the installment accounts receivable are classified as $1,200,000 current and $1,200,000 noncurrent. The income tax rate is 30% for all years. 56. The deferred tax asset to be recognized is

d. $900,000 noncurrent. ($3,000,000 × 30%) = $900,000.

On January 1, 2018, Yancey, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Holt Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement. (a) The agreement requires equal rental payments at the beginning each year. (b) The fair value of the building on January 1, 2018 is $6,000,000; however, the book value to Holt is $4,950,000. (c) The building has an estimated economic life of 10 years, with no residual value. Yancey depreciates similar buildings on the straight-line method. (d) At the termination of the lease, the title to the building will be transferred to the lessee. (e) Yancey's incremental borrowing rate is 11% per year. Holt Warehouse Co. set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is known by Yancey, Inc. (f) The yearly rental payment includes $15,000 of executory costs related to taxes on the property What is the amount of the total annual lease payment?

d. $902,703 $887,703 + $15,000 = $902,703.

Gage Co. purchases land and constructs a service station and car wash for a total of $540,000. At January 2, 2018, when construction is completed, the facility and land on which it was constructed are sold to a major oil company for $600,000 and immediately leased from the oil company by Gage. Fair value of the land at time of the sale was $60,000. The lease is a 10-year, noncancelable lease. Gage uses straight-line depreciation for its other various business holdings. The economic life of the facility is 15 years with zero salvage value. Title to the facility and land will pass to Gage at termination of the lease. A partial amortization schedule for this lease is as follows: Payments Interest Amortization Balance Jan. 2, 2018 $600,000.00 Dec. 31, 2018 $97,646.71 $60,000.00 $37,646.71 562,353.29 Dec. 31, 2019 97,646.71 56,235.33 41,411.38 520,941.91 Dec. 31, 2020 97,646.71 52,094.19 45,552.52 475,389.39 96. The total lease-related expenses recognized by the lessee during 2019 is

d. $92,235. [($600,000 - $60,000) ÷ 15] + $56,235 = $92,235.

At the beginning of 2018; Elephant, Inc. had a deferred tax asset of $20,000 and a deferred tax liability of $30,000. Pre-tax accounting income for 2018 was $1,500,000 and the enacted tax rate is 40%. The following items are included in Elephant's pre-tax income: Interest income from municipal bonds $120,000 Accrued warranty costs, estimated to be paid in 2019 $260,000 Operating loss carryforward $190,000 Installment sales profit, will be taxed in 2019 $130,000 Prepaid rent expense, will be used in 2019 $60,000 77. Which of the following is required to adjust Elephant, Inc.'s deferred tax asset to its correct balance at December 31, 2018?

d. A debit of $84,000 ($260,000 × .40) - $20,000 = $84,000.

On January 1, 2018, Yancey, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Holt Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement. (a) The agreement requires equal rental payments at the beginning each year. (b) The fair value of the building on January 1, 2018 is $6,000,000; however, the book value to Holt is $4,950,000. (c) The building has an estimated economic life of 10 years, with no residual value. Yancey depreciates similar buildings on the straight-line method. (d) At the termination of the lease, the title to the building will be transferred to the lessee. (e) Yancey's incremental borrowing rate is 11% per year. Holt Warehouse Co. set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is known by Yancey, Inc. (f) The yearly rental payment includes $15,000 of executory costs related to taxes on the property. If the lease was nonrenewable, there was no bargain purchase option, title to the building does not pass to the lessee at termination of the lease and the lease term was only for eight years, what type of lease would this be for the lessee?

d. Capital lease 8/10 = .8 > 75% of economic life.

On January 2, 2018, Gold Star Leasing Company leases equipment to Brick Co. with 5 equal annual payments of $160,000 each, payable beginning January 2, 2018. Brick Co. agrees to guarantee the $100,000 residual value of the asset at the end of the lease term. Brick's incremental borrowing rate is 10%, however it knows that Gold Star's implicit interest rate is 8%. What journal entry would Gold Star make at January 2, 2018 assuming this is a direct-financing lease? PV Annuity Due PV Ordinary Annuity PV Single Sum 8%, 5 periods 4.31213 3.99271 .68508 10%, 5 periods 4.16986 3.79079 .62092

d. Cash 160,000 Lease Receivable 598,449 Equipment 758,449 ($160,000 × 4.31213) + ($100,000 × .68508) = $758,449.

Which of the following differences would result in future taxable amounts?

d. Expenses or losses that are tax deductible before they are recognized in financial income.

Which of the following statements is correct?

d. For sales-type leases, lessor revisions in estimated unguaranteed residual values can take the form of both upward and downward adjustments.

Uncertain tax positions I. Are positions for which the tax authorities may disallow a deduction in whole or in part. II. Include instances in which the tax law is clear and in which the company believes an audit is likely. III. Give rise to tax expense by increasing payables or increasing a deferred tax liability.

d. I only.

Which of the following are reasons why a company is involved in leasing to other companies? I. Interest revenue. II. High residual values. III. Tax incentives. IV. Guaranteed bargain purchase options.

d. I, II, and III.

Which of the following would be included in the Lease Receivable account? I. Guaranteed residual value. II. Unguaranteed residual value. III. Executory costs IV. Penalty for failure to renew.

d. I, II, and IV.

Minimum lease payments may include: I. a penalty for failure to renew. II. executory costs. III a bargain purchase option. IV. a guaranteed residual value.

d. I, III, and IV

Which of the following statements is true when comparing the accounting for leasing transactions under GAAP with IFRS?

d. IFRS does not provide detailed guidance for leases of natural resources, sale-leasebacks, and leveraged leases.

At December 31, 2017 Raymond Corporation reported a deferred tax liability of $240,000 which was attributable to a taxable temporary difference of $800,000. The temporary difference is scheduled to reverse in 2021. During 2018, a new tax law increased the corporate tax rate from 30% to 40%. Raymond should record this change by debiting

d. Income Tax Expense for $80,000. $800,000 × (.40 - .30) = $80,000 Income Tax Expense.

Which of the following will not result in a temporary difference?

d. Interest received on municipal obligations.

Foltz Corp.'s 2018 income statement had pretax financial income of $500,000 in its first year of operations. Foltz uses an accelerated cost recovery method on its tax return and straight-line depreciation for financial reporting. The differences between the book and tax deductions for depreciation over the five-year life of the assets acquired in 2018, and the enacted tax rates for 2018 to 2022 are as follows: Book Over (Under) Tax Tax Rates 2018 $(100,000) 35% 2019 (130,000) 30% 2020 (30,000) 30% 2021 120,000 30% 2022 140,000 30% There are no other temporary differences. In Foltz's December 31, 2018 balance sheet, the noncurrent deferred income tax liability and the income taxes currently payable should be Noncurrent Deferred Income Taxes Income Tax Liability Currently Payable

d. Noncurrent Deferred Income Tax Liability- $30,000 Income Tax Currently Payable- $140,000 ($100,000 × 30%) = $30,000; ($500,000 - $100,000) × 35% = $140,000.

Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2018 for the purpose of leasing a machine to be used in its manufacturing operations. The following data pertain to the agreement: (a) The term of the noncancelable lease is 3 years with no renewal option. Payments of $574,864 are due on January 1 of each year. (b) The fair value of the machine on January 1, 2018, is $1,600,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease. (c) Alt depreciates all machinery it owns on a straight-line basis. (d) Alt's incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8% implicit rate used by Yates. (e) Immediately after signing the lease, Yates finds out that Alt Corp. is the defendant in a suit which is sufficiently material to make collectibility of future lease payments doubtful. 80. Which of the following lease-related revenue and expense items would be recorded by Yates if the lease is accounted for as an operating lease?

d. Rent Revenue and Depreciation Expense

Tanner, Inc. incurred a financial and taxable loss for 2018. Tanner therefore decided to use the carryback provisions as it had been profitable up to this year. How should the amounts related to the carryback be reported in the 2018 financial statements?

d. The refund claimed should be shown as a benefit due to loss carryforward in 2018.

Which of the following is an advantage of captive leasing companies over the other players in the leasing market?

d. They have the point-of-sale advantage in finding leasing customers.

A company uses the equity method to account for an investment for financial reporting purposes. This would result in what type of difference and in what type of deferred income tax? Type of Difference Deferred Tax

d. Type of Difference- Temporary Deferred Tax-Liability

Jamar Co. sold its headquarters building at a gain, and simultaneously leased back the building. The lease was reported as a capital lease. At the time of the sale, the gain should be reported as

d. a deferred gain.

When a company sells property and then leases it back, any gain on the sale should usually be

d. deferred and recognized as income over the term of the lease.

If the residual value of a leased asset is guaranteed by a third party

d. it is treated by the lessee as an additional payment and by the lessor as realized at the end of the lease term.

Companies are permitted to offset any balances in income taxes payable against

d. related income tax refund receivable or prepaid income taxes balances.

A major distinction between temporary and permanent differences is

d. temporary differences reverse themselves in subsequent accounting periods, whereas permanent differences do not reverse.

Lessees prefer to account for their leases as operating lease because:

d. this decreases the amount of liability reported.