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11-1 Solutions
CHAPTER 11
LIABILITIES: OFF-BALANCE-SHEET FINANCING,
RETIREMENT BENEFITS, AND INCOME TAXES
Questions, Exercises, and Problems: Answers and Solutions
11.2 Using an executory contract to achieve off-balance-sheet financing results
in the recognition of neither an asset (for example, leased assets) nor a
11.3 The financial components approach records the benefits to each entity as
an asset and the obligations of each entity as a liability. Although
11.4 All executory contracts do not carry the same amounts of risk. A firm
might back out of a purchase commitment more easily than an
employment contract or lease contract. Furthermore, the expected benefits
Solutions 11-2
11-3 Solutions
11.5 The use of a special purpose entity enhances the ability of a firm to
demonstrate that it has transferred control of the receivables to the
11.6 Accrual accounting recognizes a cost as an expense in the period when a
11.7 Laws require firms to contribute funds to an independent trustee to
11.8 The amounts that pension plans pay to retirees derive from the employer’s
contributions plus earnings from investments. Earnings from pension
11.9 Firms typically have multiple pension plans for their different groups of
employees (for example, wage earners versus corporate officers, domestic
11.10 GAAP allows firms to defer and amortize changes in prior service costs and
actuarial gains and losses that originate during a period. The rationale is
Solutions 11-4
11-5 Solutions
11.11 GAAP requires firms to increase pension expense for the increase in the
pension obligation that results from the passage of time (that is, the
11.12 Subtracting the expected instead of the actual return on investments
11.13 Income tax expense equals income taxes payable currently plus (minus)
11.14 This statement is incorrect. In order for deferred taxes to be a loan, there
When Timing Differences Originate:
Income Tax Expense ..................................................... X
Deferred Tax Liability ............................................. X
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
+X
–X
IncSt → RE
When Timing Differences Reverse:
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
–X
+X
IncSt → RE
There are no cash or other asset flows involved and, therefore, no loan.
Another approach is to raise the question: How would cash flows have
differed if a firm used the same methods of accounting for book as it used
for tax? The response is that cash flows would have been the same even
though deferred income taxes would have been eliminated. Thus,
Solutions 11-6
11-7 Solutions
11.15 Deferred tax assets (liabilities) arise when a firm recognizes revenue
11.16 When firms choose accounting methods that result in recognizing income
earlier for book purposes than for tax purposes, they delay the payment of
taxes. Yet, income tax expense does not reflect the benefit of the delayed
11.17 Analysts often forecast earnings and need to make some assumption about
11.18 Information on individual deferred tax assets and deferred tax liabilities
provide information about a firm’s operating, investing, and financing
Solutions 11-8
11.19 (Cypres Appliance Store; using accounts receivable to achieve off-balance-
a. (1) January 2, 2008
Cash .................................................................. 92,593
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
+92,593
+92,593
To record bank loan.
December 31, 2008
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
+100,000
–100,000
To record collections from customers.
Interest Expense (= .08 X $92,593) .................. 7,407
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
–100,000
–92,593
–7,407
IncSt → RE
To record interest expense on loan for 2008 and re-
payment of the loan.
(2) Cash .................................................................. 92,593
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
+92,593
–7,407
IncSt → RE
–100,000
To record sale of accounts receivable; an alternative
title for the loss account is interest expense.
11-9 Solutions
11.19 continued.
b. Both transactions result in an expense of $7,407 for 2008 for this
c. Cypres Appliance Store must attempt to shift credit and interest rate
risk to the bank. The bank should have no rights to demand additional
11.20 (P. J. Lorimar Company; using inventory to achieve off-balance-sheet
financing.)
a. (i) January 2, 2008
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
+300,000
+300,000
To record bank loan.
December 31, 2008
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
+30,000
–30,000
IncSt → RE
To record interest expense for 2008.
December 31, 2009
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
+363,000
+363,000
IncSt → RE
Solutions 11-10
11-11 Solutions
11.20 a. continued.
Cost of Goods Sold ........................................... 200,000
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
–200,000
–200,000
IncSt → RE
To record cost of tobacco inventory sold.
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
–363,000
–330,000
–33,000
IncSt → RE
To record interest expense for 2009 and repayment of
loan.
(ii) January 2, 2008
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
+300,000
+300,000
IncSt → RE
To record “sale” of tobacco to bank.
Cost of Goods Sold ........................................... 200,000
Inventory ...................................................... 200,000
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
–200,000
–200,000
IncSt → RE
To record cost of tobacco “sold”.
b. Both transactions result in a total of $100,000 income for the two years
Solutions 11-12
11-13 Solutions
11.20 continued.
c. P. J. Lorimar Company must shift the risk of changes in storage costs
11.21 (Preparing journal entry for pension plan.) (Amounts in Millions)
2008
Pension Expense ............................................................. 1,050
Pension Asset ($46,203 – $45,582) ................................ 621
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
+621
–1,699
–1,050
IncSt → RE
–526
+2,061
OCI →
AOCI
+783
OCI →
AOCI
To record pension expense and pension funding for 2008,
11.22 (Preparing journal entry for pension plan.) (Amounts in Millions)
2008
Pension Expense ............................................................. 340
Solutions 11-14
11.22 continued.
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
–19
–123
–340
IncSt → RE
+322
OCI →
AOCI
+122
OCI →
AOCI
To record pension expense, pension funding, the increase
in net pension liabilities, and other comprehensive income
related to the change in actuarial and performance gains
and losses.
11.23 (Preparing journal entry for health care plan.) (Amounts in Millions)
2008
Health Care Expense ..................................................... 2,183
Health Care Liability [($30,863 – $5,460) – ($39,274 –
$6,497)] ....................................................................... 7,374
Solutions 11-16
11.24 a. continued.
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
+495.4
–504.4
IncSt → RE
+9.0
To record income tax expense, income tax payable,
and the change in deferred taxes for 2006.
2007
Income Tax Expense ................................................ 648.2
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
+622.8
–648.2
IncSt → RE
+25.4
To record income tax expense, income tax payable,
2008
Income Tax Expense ................................................ 749.6
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
–26.0
–749.6
IncSt → RE
+775.6
To record income tax expense, income tax payable,
and the change in deferred taxes for 2008.
b. The firm has overfunded retirement benefit plans, suggesting that the
firm has contributed more cash to the pension plan and, thereby,
11-17 Solutions
11.25 (Preparing journal entries for income tax expense.) (Amounts in Millions)
a. 2006
Income Tax Expense ................................................ 272
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
+96
+368
–272
IncSt → RE
To record income tax expense, a claim for a refund in
taxes paid previously, and the increase in the deferred
tax liability for 2006.
2007
Income Tax Expense ................................................ 341
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
–74
–341
IncSt → RE
+415
To record income tax expense, income tax payable,
and the decrease in the deferred tax liability for 2007.
2008
Income Tax Expense ................................................ 390
Assets
=
Liabilities
+
Shareholders'
Equity
(Class.)
+46
–390
IncSt → RE
+344
To record income tax expense, income tax payable,
and the increase in the deferred tax liability for 2008.
Solutions 11-18
11.25 continued.
b. The firm operated at a net taxable loss for 2006 and likely received a
refund of taxes paid in previous years due to net operating loss
carryforward provisions in the income tax law. The net taxable loss
likely occurred because the firm acquired new equipment for which
11.26 (Pownall Company; deriving permanent and temporary differences from
financial statement disclosures.)
Change in
a. Income Tax = Income Taxes + Deferred Tax
Expense Currently Payable Liability
Temporary = Changes in Deferred Tax Liability/.40
Differences
Because income tax expense exceeds income taxes payable, book
income exceeded taxable income.
b. Taxable Income: $48,000/.40 ............................................... $ 120,000
11-19 Solutions
Solutions 11-20
11.27 (Lilly Company; reconstructing information about income taxes.)
LILLY COMPANY
Illustrations of Timing Differences and Permanent Differences
Financial Type of Income Tax
Statements Difference Return
Operating Income Except
Depreciation ..................... $ 427,800 (6) -- $ 427,800 (4)
Depreciation ........................... (322,800) (g) Temporary (358,800) (3)
Order and derivation of computations:
(g) Given.
(1) $148,800 = $190,800 – $42,000.
(5) Taxable income on financial statements is $105,000 = $42,000/.40.
Total financial statement income before taxes, including
