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Deferred Assets and Liabilities
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Overview
Complete a four-part assessment in which you will compute values, prepare journal entries, and provide written explanations.
Note: An accounting cycle requires specific steps that need to be executed in a sequence. The assessments in this course are presented in sequence and must be completed in order.
Companies must present financial information to the investment community that provides a clear picture of present and potential tax obligations and tax benefits.
By successfully completing this assessment, you will demonstrate your proficiency in the following course competencies and assessment criteria:
Competency 1: Define financial accounting conventions to support practice as a professional in the field.
*Apply tax rates to temporary differences.
*Analyze carryback and carryforward issues.
* Competency 3: Evaluate economic resources for an enterprise.
* Apply procedures for a capital lease.* Apply procedures for a sales-type lease.
Deferred Assets and Liabilities
Context
Companies spend a considerable amount of time and effort to minimize their income tax payments—and with good reason. Income taxes are major costs of doing business for most business organizations, regardless of the form of ownership.
Leasing of an asset has been around for many years, especially in the private sector. Individuals have utilized this form of asset acquisition for the purchase of realty, personal property, and even services. It has allowed them to acquire assets for little or no money down, use the asset for a determinable period of time, and then simply return the asset and terminate the lease agreement.
Today, leasing of capital assets is the fastest growing form of capital investment for corporations. It allows businesses to acquire large high-dollar assets with little or no responsibility for their maintenance and allows them to trade those assets in for newer models at the end of the lease. Consequently, accounting procedures for handling these transactions has undergone significant change over the last 25 years.
Questions to Consider
As you prepare to complete this assessment, you may want to think about other related issues to deepen your understanding or broaden your viewpoint. You are encouraged to consider the questions below and discuss them with a fellow learner, a work associate, an interested friend, or a member of your professional community. Note that these questions are for your own development and exploration and do not need to be completed or submitted as part of your assessment.
* What are the guidelines for determining the most advantageous type of lease for an asset?* What is the advantage of an operating lease versus a capital lease?* What is the difference between a financial lease and a capital lease?
Resources
Deferred Assets and Liabilities
FACTORS THAT IMPACT TAXES
- Economic factors: Microeconomic factors (e.g., elasticity, type of entity)Macroeconomic factors (e.g., inflation, political systems)
- Social factors:Demographics (e.g., aging population, birth rates)Standard of living (e.g., crime rates, education)Savings rates (e.g., incentives, cost of living)
- Political factors:Government revenue (e.g., income tax, sales tax)Type of tax (e.g., progressive, regressive)Income redistribution (e.g., political system, types)
- Legal/regulatory factors:Justification for tax system (e.g., tax avoidance, tax evasion)Types of entities (e.g., partnership, corporation)Economic (e.g., employees vs. subcontractors, insurance deduction)
- Emerging trend factors:Economic (e.g., command vs. market economies, trade agreements)Technology (e.g., information access, compliance)Intangible taxation (e.g., changing laws, changing regulations)
CREDITS
Subject Matter Expert:Timothy Price
Interactive Design:Tara Schiller
Instructional Designer: JodiRae Foss
Project Manager:Lon Wiessenberger
- Laux, R. C. (2013). The association between deferred tax assets and liabilities and future tax payments. The Accounting Review, 88(4), 1357–1383. Liabilities/Equities – Chapter 13.* This chapter reviews accounting for leases.
- Harrington, C., Smith, W., & Trippeer, D. (2012). Deferred tax assets and liabilities: Tax benefits, obligations and corporate debt policy. Journal of Finance and Accountancy, 1–18. Retrieved from http://www.aabri.com/manuscripts/121240.pdf
- Spiceland, J. D., Sepe, J. F., Nelson, M. W., & Thomas, W. B. (2016). Intermediate Accounting (8th ed.). New York, NY: McGraw-Hill Education.Chapter 15, “Leases,” pages 852–931.This chapter focuses on issues related to liabilities arising in connection with leases, and in particular those that produce such debtor/creditor relationships, referred to as capital leases. Pay particular attention to leases that do not produce a debtor/creditor relationship, but instead are accounted for as rental agreements.
- Chapter 16, “Accounting for Income Taxes,” pages 932–995.This chapter presents accounting issues that focus on accounting and reporting for the effects of income taxes, particularly defining and illustrating temporary differences which are the basis for recognizing deferred tax assets and deferred tax liabilities.
Deferred Assets and Liabilities
Assessment Instructions
Note: Do not proceed with this assessment until you have reviewed faculty feedback on Assessment 4.
This assessment has four parts. The Assessment 5 Data Sheet contains the necessary information for all four parts. Record your answers in the Assessment 5 Template. Submit the completed template for this assessment. Both documents are linked in the Resources under the Required Resources heading.
Imagine your boss has handed you four client files to complete by EOD (end of day.) However, several of the clients require written explanations of your reasoning.
Part 1: Temporary Differences
Use the information for Part 1 in the Assessment 5 Data Sheet to complete the following:
- Prepare the journal entry to record income tax expense, deferred income taxes, and income tax payable for 2015, 2016, and 2017.
- Assuming there were no temporary differences prior to 2015, indicate how deferred taxes will be reported on the 2017 balance sheet. Sharp’s product warranty is for 12 months.
- Explain your reasoning. Use the blank area in the template following the journal entries to make your notes.
- Prepare the income tax expense section of the income statement for 2017, beginning with the line “Pretax financial income.”
- Where appropriate, show all calculations leading to the final solution.
Part 2: Carryback and Carryforward
Use the information in Part 2 of the Assessment 5 Data Sheet to complete the following:
- Prepare the journal entries for the years 2015 to 2019 to record income tax expense and the effects of the net operating loss carrybacks and carryforwards assuming Bryan Clark Company uses the carryback provision.
- All income and losses relate to normal operations. (In recording the benefits of a loss carryforward, assume that no valuation account is deemed necessary.
- Where appropriate, show all calculations leading to the final solution.
Deferred Assets and Liabilities
Part 3: Lessee Entries: Capital Lease
Use the information in Part 3 of the Assessment 5 Data Sheet to complete the following:
- Identify and explain the type of lease. Use the blank area in the template following the journal entries to make your notes.
- Compute the present value of the minimum lease payments.
- Prepare all necessary journal entries for Southern for this lease through January 1, 2016.
- Where appropriate, show all calculations leading to the final solution.
Part 4: Lessee-Lessor Entries: Sales-Type Lease
Use the information in Part 4 of the Assessment 5 Data Sheet to complete the following:
- Discuss the nature of this lease to Capital and Hinton. Use the blank area in the template following the journal entries to make your notes.
- Calculate the amount of the annual rental payment.Prepare all the necessary journal entries for Hinton for 2015.
- Prepare all the necessary journal entries for Capital for 2015.
- Where appropriate, show all calculations leading to the final solution.
Deferred Assets and Liabilities
Assessment Data Sheet
Part 1: Temporary Differences
Sharp Company has two temporary differences between its income tax expense and income taxes payable. The information is shown below.
| 2015 | 2016 | 2017 | |
| Pretax financial income | $420,000 | $455,000 | $472,500 |
| Excess depreciation expense on tax return | (15,000) | (20,000) | (5,000) |
| Excess warranty expense in financial income | 10,000 | 5,000 | 4,000 |
| Taxable income | $415,000 | $440,000 | $471,500 |
The income tax rate for all years is 40%.
Part 2: Carryback and Carryforward
The pretax financial income (or loss) figures for Bryan Clark Company are as follows.
| 2013 | $ 80,000 |
| 2014 | 125,000 |
| 2015 | 40,000 |
| 2016 | (80,000) |
| 2017 | (190,000) |
| 2018 | 60,000 |
| 2019 | 50,000 |
Pretax financial income (or loss) and taxable income (loss) were the same for all years involved. Assume a 45% tax rate for 2013 and 2014 and a 40% tax rate for the remaining years.
Part 3: Lessee Entries: Capital Lease
On January 1, 2015, Southern, Inc. signed a 10-year non-cancelable lease for a machine. The terms of the lease called for Southern to make annual payments of $17,336 at the beginning of each year, starting January 1, 2015. The machine has an estimated useful life of 12 years.
The machine reverts back to the lessor at the end of the lease term. Southern uses the straight-line method of depreciation for all of its plant assets. Southern’s incremental borrowing rate is 6%, and the Lessor’s implicit rate is unknown.
Part 4: Lessee-Lessor Entries: Sales-Type Lease
On January 1, 2015, Capital Corp. leased equipment to Hinton Corporation. The following information pertains to this lease.
- The term of the noncancelable lease is 12 years, with no renewal option. The equipment reverts to the lessor at the termination of the lease.
- Equal rental payments are due on January 1 of each year, beginning in 2015.
- The fair value of the equipment on January 1, 2015, is $225,000, and its cost is $180,000.
- The equipment has an economic life of 16 years. Hinton depreciates all of its equipment on a straight-line basis.
- Capital set the annual rental to ensure an 11% rate of return. Hinton’s incremental borrowing rate is 12%, and the implicit rate of the lessor is unknown.
- Collectability of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs yet to be incurred by the lessor.
Below is a partial answer to the above homework questions by one of our writers. If you are interested in a custom non plagiarized top quality answer, click order now to place your order.
Deferred Assets and Liabilities
Part 1: Temporary Differences
| Date | Account Title | Debit | Credit |
| Section 1: Journal entries | |||
| 2015 | Income tax expense | 168,000 | |
| Deferred tax asset (10,000 x 40%) | 4,000 | ||
| Deferred tax liability (15,000 x 40%) | 6,000 | ||
| Income tax payable (415,000 x 40%) | 166,000 | ||
| 2016 | Income tax expense | 182,000 | |
| Deferred tax asset (5,000 x 40%) | 2,000 | ||
| Deferred tax liability (20,000 x 40%) | 8,000 | ||
| Income tax payable (440,000 x 40%) | 176,000 | ||
| 2017 | Income tax expense | 189,000 | |
| Deferred tax asset (4,000 x 40%) | 1,600 | ||
| Deferred tax liability (5,000 x 40%) | 2,000 | ||
| Income tax payable (471,500 x 40%) | 188,600 | ||
| Section 2: Balance sheet entries | |||
| Current asset | |||
| Deferred tax asset (4000+2000+1600) | 7,600 | ||
| Long-term liability | |||
| Deferred tax liability (6000+8000+2000) | 16,000 | ||
| Section 3: Income tax expense | |||
| Pretax income | 472,500 | ||
| Less: | Income tax expenses | 188,600 | |
| Net deferred tax | 400 | ||
| Net income post tax | 283,500 |
Explanation:
2015
| Deferred tax asset = 10,000 x 40% = 4000 |
| Deferred tax liability 15,000 x 40% = 6000 |
| Income tax payable 415,000 x 40% = 166,000 |
2016
| Income tax expense |
| Deferred tax asset 5,000 x 40% = 2000 |
| Deferred tax liability 20,000 x 40% = 8000 |
| Income tax payable 440,000 x 40% = 176,000 |
2017
| Deferred tax asset = 4,000 x 40% = 1600 |
| Deferred tax liability = 5,000 x 40% = 2000 |
| Income tax payable = 471,500 x 40% = 188,600 |
Part 2: Carryback and Carryforward
| Date | Account Title | Debit | Credit | |
| 1 | 2015 | Income Tax Expense | $16,000 | |
| 2 | Income Tax Payable | $16,000 | ||
| 3 | 2016 | Income Tax Refund Receivable | $36,000 | |
| 4 | Benefit Due to Loss Carryback | $36,000 | ||
| 5 | 2017 | Income Tax Refund Receivable | $16,000 | |
| 6 | Benefit Due to Loss Carryback | $16,000 | ||
| 7 | Deferred Tax Asset | $60,000 | ||
| 8 | Benefit Due to Loss Carryforward | $60,000 | ||
| 9 | 2018 | Income Tax Expense | $24,000 | |
| 10 | Deferred Tax Asset | $24,000 | ||
| 11 | 2019 | Income Tax Expense | $20,000 | |
| 12 | Deferred Tax Asset | $20,000 |
Calculations
1. Income tax expense
40,000 x 40%
= $16,000
3. Income tax refund receivable
80,000 x 45%
= $36,000
5. Income tax refund receivable
40,000 x 40%
= $16,000
7. Deferred Tax Asset
[(190,000 – 40,000) x 40%]
= $60,000
9. Income Tax Expense
(60,000 x 40%)
= $24,000
11. Income Tax Expense
50,000*40%
= $20,000
Part 3: Lessee Entries: Capital Lease
| Date | Account Title | Debit | Credit |
| Jan 2015 | Leased equipment | $135,250 | |
| Lease liability | $135,250 | ||
| Jan 2015 | Lease liability | $17,336 | |
| Cash | $17,336 | ||
| Jan 2015 | Depreciation | $13,525 | |
| Accumulated depreciation | $13,525 | ||
| Jan 2016 | Lease liability | $10,261 | |
| Interest expense | $7,075 | ||
| Cash | $17,336 |
Explanation:
The lease can be considered a capital lease. This is because the lease life exceeds 75% of the asset’s life. According to FASB, a capital lease may meet either of the following criteria:
- The lease life is more than 75% of asset’s life.
- Ownership transfer is done at the end of the lease
- Present value is higher than 90% of the asset’s fair value
- The leasee has an option to buy the lease asset below market value once the lease has expired.
Given that the lease life exceeds 75% of asset’s life, it is considered a capital lease. The calculations are provided as below.
10/12 x 100 = 83.3%
Equipment is capitalized at the minimum of fair value and present value of the lease payments. However, there is no fair value given and thus present value of minimum lease payments is used.
Depreciation calculation:
= Capitalized amount / Life of project
= 135,250 / 10
= $13,525
Part 4: Lessee-Lessor Entries: Sales-Type Lease
| Date | Account Title | Debit | Credit |
| Lessor Accounts | |||
| Lease receivables | 225,000 | ||
| Equipment | 225,000 | ||
| Installment received | |||
| Cash | 31,224 | ||
| Lease receivable | 31,224 | ||
| Hilton’s Accounts | |||
| Leased asset equipment | 225,000 | ||
| Lease liability | 225,000 | ||
| Depreciation | 14,062.5 | ||
| Accumulated depreciation | 14,062.5 |
Explanation:
No interest factor is considered because payment for the lease is made on 1st January. This means that interest has not accumulated.
The type of lease in this case is a capital lease. This is because the lease term is equivalent to 75% of its economic life or more. To calculate 75% of the lease term, the following calculation is done.
12/16 x 100 = 75%
Given that the lease period is 12 years while economic life is 16 years, it means that the lease period is 75%……..
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