Chapter 2
Asset and Liability Valuation
and Income Recognition
2-11
in whole or in part.
income statement.
(6) PCU records depreciation expense of $24,000 [($48,000-$0)/2], and adjusts
$2,000).
related to the purchase, use, and disposition of the equipment.
Chapter 2
Asset and Liability Valuation
and Income Recognition
2-12
in whole or in part.
2.15 Effect of Valuation Method for Monetary Asset on Balance Sheet and Income
Statement.
a. Assume that Alfa Romeo accounts for this note throughout the three years using
its initial present value.
(1) The cash costs of the automobile increases inventory (and decreases cash).
(2) The sale of the car triggers recognition of sales on the income statement of
$45,000, and recognition of two assets—cash of $5,000 and a receivable of
$40,000. In addition, Automobile Inventory would be reduced for the cost of the
automobile ($30,000), and Cost of Goods Sold in the same amount would be
recognized on the income statement.
Cash…………………………………………………………………………. 5,000
$12,814 ($14,414 – $1,600) adjusts downward the value of the Note Receivable.
(4) Alfa Romeo receives the second annual payment of ($14,414), increasing
the Note Receivable.
(5) Alfa Romeo receives the final annual payment of ($14,414), increasing cash,
the value of the Note Receivable to $0.
Chapter 2
Asset and Liability Valuation
and Income Recognition
2-13
in whole or in part.
b. Assume that Alfa Romeo values this note receivable at fair value each year.
(1) Same as (1) in Part a.
(2) Same as (2) in Part a.
(3) Same as (3) in Part a.
(4) The rise in interest rates reduces the fair value of the Note Receivable by
(5) Alfa Romeo receives the second annual payment of ($14,414), increasing
Note Receivable.
statement.
Chapter 2
Asset and Liability Valuation
and Income Recognition
2-14
in whole or in part.
(7) Alfa Romeo receives the final annual payment of ($14,414), increasing cash,
to $0.
automobile.
d. In Part a, the balance sheet suffers at the end of 2010 and 2011 because the note
receivable is overvalued. The overvaluation is due to the market interest rate
that Alfa Romeo ought to be realizing on the note being higher than what the
company is actually realizing. Thus, the note is worth less than its adjusted
adjustments.
2.16 Deferred Tax Assets.
a. Biosante Pharmaceuticals discloses that the amount of the net operating loss
carryforwards at the end of 2008 is $62,542,000. This amount reflects the
income tax “shield” available due to the $62,542,000 tax loss carryforwards.
The link between these two amounts is that the deferred tax asset represents the
tax effect of the tax loss carryforwards. Generally, this text uses 35–40% as the
b. The company has recorded a valuation allowance for the deferred tax asset
equal to the entire amount of the deferred tax asset. What this means is that the
company believes that it is “more likely than not” to use its deferred tax assets
before they expire. This implies that management is not optimistic about the
Chapter 2
Asset and Liability Valuation
and Income Recognition
2-15
in whole or in part.
c. The increase in the valuation allowance was achieved by the following entry:
symbolically represented as follows:
Taxes at U.S. Federal Statutory Rate ………………………………………. $ (6,030,952)
State Taxes, Net of Federal Benefit ………………………………………… (568,133)
2.17 Interpreting Income Tax Disclosures.
b. Income before income taxes for financial reporting exceeded taxable income
because the net deferred tax liability increased between the end of 2013 and the
end of 2014. In addition, total income tax expense exceeded income taxes
currently payable.
d. ABC recognizes insurance expense earlier for financial reporting than for tax
reporting, giving rise to a deferred tax asset for the future savings in income
Chapter 2
Asset and Liability Valuation
and Income Recognition
2-16
in whole or in part.
ABC paid out more in actual claims during 2013 than it recognized as an
expense. The increase in the deferred tax asset for self-insured benefits between
the end of 2013 and the end of 2014 indicates that ABC recognized more
expense than it paid in actual claims during 2014.
between the end of 2013 and the end of 2014 suggests that inventories increased
during 2014.
f. The deferred tax asset related to the health care obligation indicates that ABC
and the end of 2014 suggests a decline in the number of employees, lower
health care benefits, or lower health care costs. The deferred tax liability related
to pension indicates that ABC has contributed larger amounts cumulatively to
its pension fund than it has recognized as expenses for financial reporting. The
g. The deferred tax asset related to uncollectible accounts indicates that ABC
recognizes losses for uncollectibles earlier for financial reporting than for tax
reporting. The deferred tax asset indicates the future savings in income taxes the
firm will realize when it writes off actual uncollectible accounts. The increasing
h. The deferred tax liability indicates that ABC recognizes depreciation earlier for
tax reporting than for financial reporting. The increasing amounts for this
deferred tax liability suggest that ABC increased its capital expenditures each
year and therefore had more depreciable assets in the early years of their lives,
exceeds accelerated depreciation.
Chapter 2
Asset and Liability Valuation
and Income Recognition
2-17
in whole or in part.
2.18 Interpreting Income Tax Disclosures.
a. In 2008, the deferred income tax provision is positive, whereas in 2007, it is
negative. This shows that income before taxes exceeded taxable income in
2008, but the reverse was true for 2007.
available. However, it is not needed because the components of the provision
are such that the deferred provision was negative, indicating that the company
reported higher taxable income in 2007 than income before taxes.
be no associated taxable income for these amounts. As a consequence, the taxes
already paid on the amounts deferred represent an asset of PPD, and they are
categorized appropriately as deferred tax assets on the balance sheet.
will be higher than income before taxes. Accordingly, these amounts represent a
future tax liability and are categorized as deferred tax liabilities.
e. Accelerated depreciation deductions, all else equal, reduce current taxable
with a deferred tax liability.
f. Although the limited income tax footnote disclosures can provide only limited
insight into the overall reported growth and profitability (because there are
many other aspects of reported profitability than are revealed in the footnote),
Chapter 2
Asset and Liability Valuation
and Income Recognition
2-18
in whole or in part.
for property and equipment suggests that a company is continuing to make
investments in property and equipment, which generally occurs when managers
are bullish on future prospects. Similarly, a buildup in the deferred tax asset for
deferred revenues would indicate that the company is generating growth in
advance with cash relative to paying ratably, this could accompany an increase,
a decrease, or a flat pattern in sales. However, what the income tax footnote is
frequently useful for is quickly identifying accrual accounting differences from
cash flows. A quick glance at PPD’s tax footnote reveals that it (i) defers costs
identify possible accounting quality issues.
2.19 Interpreting Income Tax Disclosures.
a. Nike’s income before income taxes (also referred to as book income) exceeded
taxable income for 2007 because total income tax expense exceeded income
taxes currently payable (that is, $708.4 million income tax expense versus
$674.1 currently payable).
c. The adjustment to net income to compute cash flow from operations will be a
subtraction because the cash payment is larger than income tax expense.
doubtful accounts estimates).
e. Nike recognizes deferred compensation expense earlier for financial reporting
than for tax reporting, giving rise to a future tax benefit that the firm will realize
Chapter 2
Asset and Liability Valuation
and Income Recognition
2-19
in whole or in part.
deferred tax asset for deferred compensation suggests that Nike increase the
number of employees or the deferred compensation benefits.
f. The amount of the deferred tax asset for foreign loss carryforwards increased
future profits that can be offset by tax loss carryforwards for tax reporting
purposes.
g. Apparently, when Nike acquired Umbro, it was able to deduct a large number of
waiting to happen.
h. Nike recognizes foreign-source income earlier for financial reporting than for
tax reporting, thereby delaying the payment of taxes and creating a deferred tax
liability in the meantime.
liability.
2.20 Analyzing Transactions.
a.
CC AOCI RE
Common Stock
and Paid-in-
Cash +50,000 Capital +50,000
Shareholders’ Equity
+LiabilitiesAssets =
b.
CC AOCI RE
Building +35,000
Cash –5,000 Note Payable +30,000
Shareholders’ Equity
+LiabilitiesAssets =