Analysis and Use of Financial Statements w solutionsch09.docx

1、Analysis and Use of Financial Statements w solutionsch09Chapter 9 SolutionsOverview: Problem Length Problem #sS 1 - 4, 6, 11, 15M 5, 7 - 9, 13, 14, 16L 10, 121.SDeferred taxes can be found in all of the categories listed. Examples are:(i) Current liabilities may include deferred tax liabilities aris

2、ing from an installment sale with cash payments expected within one year. (ii) Deferred income tax credits resulting from the use of accelerated depreciation for tax purposes and straight line for financial reporting are reported in long-term liabilities.(iii) The stockholders equity account may inc

3、lude the deferred tax offset to the valuation allowance for available-for-sale securities or the cumulative translation adjustment account. (iv) The deferred tax asset (debit) due to accrued compensation with cash payment expected within one year is a component of current assets.(v) Long-term assets

4、 would include deferred tax assets (debits) recognized, (for example for, postretirement benefits or restructuring charges), but not expected to be funded within one year. 2.S(i) Correct: Under SFAS 109, changes in tax laws must be reflected in the deferred tax liability in the period of enactment.

5、(ii) Correct: Answer to (i) also applies to deferred tax assets. (iii) Correct: The tax consequences of events that have not been reflected in the financial statements (such as future earnings or losses) are not recognized. (iv) Incorrect: See answers to (i) and (ii) above. This statement is true fo

6、r the deferral method (see footnote 2 on text page 292). (v) Incorrect: Changes in deferred tax assets and liabilities are included in income tax expense except for those charged directly to stockholders equity. 3.Sa. Permanent differences are items of income or expense that affect either tax return

7、 income or financial income, but not both. Examples include: Tax-exempt interest income (not reported on the tax return, Interest expense on amounts borrowed to purchase tax-exempt securities (not deductible on the tax return), Tax or other nondeductible government penalties (not reported on the tax

8、 return), Statutory mineral depletion in excess of cost basis depletion (not reported in the financial statements), Premiums on key-person life insurance policies (not deductible on the tax return), Proceeds from key-person life insurance policies (not reported on the tax return).b. Permanent differ

9、ences, depending on their nature, either increase or decrease the firms effective tax rate relative to the statutory rate. For example, tax-exempt interest income (the first example listed) reduces the effective tax rate as there is no tax expense associated with this income.4.Sa. (i) If the deferre

10、d tax liability is not expected to reverse, there is no expectation of a cash outflow and the liability should be considered as equity.(ii) If the deferred tax liability is the result of a temporary difference that is expected to reverse, with consequent tax payment, it should be treated as a liabil

11、ity.b. Because both the amounts and timing of tax payments resulting from the reversals of temporary differences are uncertain, deferred taxes should be excluded from both liabilities and equity. c. The portion of the deferred tax liability that represents (the present value of) expected payments sh

12、ould be treated as debt. Accounting-based timing differences that are not expected to reverse should be treated as equity. 5.MWe begin by determining the cost of each asset using the information about asset L. Year 2 depreciation under the sum-of-the-years digits method with a five-year life is 4/15

13、ths. Therefore, the depreciable base (cost salvage value) must be $12,000/(4/15) = $45,000 and the cost must be $48,000 because salvage value is $3,000. We can now prepare a depreciation schedule for each method:Depreciation ExpenseAsset K Asset LAsset M YearStraight-lineSYD2DDB31 $ 9,000 $15,000 $1

14、9,200 2 9,000 12,000 11,520 3 9,000 9,000 6,912 4 9,000 6,000 4,147 5 9,000 3,000 3,221 Total $45,000 $45,000 $45,000 1 Base = $45,000 cost salvage value; expense = $45,000/5 = $9,000.2 Base = $45,000; expense = 5/15ths, 4/15ths, 3/15ths, etc.3 Base = $48,000 (salvage value ignored); rate = 40%Year

15、1 expense = .40 x $48,000 = $19,200, leaving $28,800Year 2 expense = .40 x $28,800 = $11,520, leaving $17,280Year 3 expense = .40 x $17,280 = $ 6,912, leaving $ 10,368Year 4 expense = .40 x $ 10,368= $ 4,147, leaving $ 6,221Year 5 expense = $ 3,221 leaving $ 3,000a. The double declining balance meth

16、od is used on the tax return for all three assets; year 2 depreciation expense under that method is $11,520.b. Financial statement depreciation expense in year two (from table on previous page) is:Asset K (straight line) $ 9,000Asset M (double declining balance) 11,520c. (i) At the end of year two,

17、accumulated depreciation equals (from table on previous page):Asset K (straight line) $18,000Asset L (SYD) 27,000Asset M (DDB) 30,720Tax return (DDB) 30,720Therefore, the deferred tax liability is:Asset K: .34 ($30,720 - $18,000) = $ 4,324.80Asset L: .34 ($30,720 - $27,000) = 1,264.80Asset M: No def

18、erred tax as the same method is used for financial and tax reporting. (ii) At the end of year five, accumulated depreciation is the same under all methods and there is no deferred tax asset or liability. 6.Sa.b. Assuming that Mother Prewitt continues to buy machines in the future, the depreciation t

19、iming difference will never reverse and there is no expected cash consequence. In this case, the deferred tax can be treated as equity.If the installment sale is not expected to recur, the tax on that sale will be paid in 2001 and will require cash. For that reason, the $27,200 of deferred taxes sho

20、uld be considered a liability when calculating liquidity, solvency, and leverage ratios. If, on the other hand, installment sales are expected to recur, such sales are no different from the depreciation case. The cash consequences of deferred tax items depend on the probability of their reversal, no

21、t on their nature. c. Under SFAS 109 (liability method), enacted changes in tax rates are recognized, and the deferred tax liabilities must be restated to amounts based on the 40% tax rate. The incremental liability is recorded as a component of income tax expense regardless of when (or if) paid. 7.

22、S Years ended June 30Amounts in $millions1997199819992000Deferred tax assets due to depreciation $ 57.7 $ 40.3 $ 49.2 $ 37.7 Effect on fixed assets of:Impairment of long-lived assets 47.0 Write-downs of operating assets 47.0 4.2 26.6 Write-downs of capitalized software - 16.0 - Total effect on fixed

23、 assets $ 94.0 $ 20.2 $ 26.6 Tax rate34%35%35%a. Expected effect on deferred tax asset$ 32.0 $ 7.1 $ 9.3 Reported change in deferred tax asset (17.3) 8.9 (11.6)Difference between expected effect and $ 49.3 $ (1.8)$ 20.9 reported change in deferred tax assetWrite-downs reduce the carrying amount of t

24、he assets on the financial statements but have no effect on the tax basis. Even if the company uses the straight-line depreciation method for both tax and financial reporting, tax depreciation would be higher than book depreciation after a write-off, generating deferred tax liabilities (credits) or

25、lowering deferred tax assets (debits). In each year, therefore, write-downs increase the deferred tax asset but depreciation expense tends to reduce it.In the table above, we compute the effect of the asset changes on the deferred tax asset for each year by multiplying the impairment plus the write-

26、off amount by the tax rate for that year. We then compare that effect with the reported change in the deferred tax asset related to depreciation.For 1998, the non-cash impairment of long-lived assets and the write-down of operating assets would generate a $32 million increase in deferred tax assets.

27、 However, the company reported a decrease of $17.3 million in deferred tax assets due to depreciation. The difference is much too high to result from current year depreciation expense. The most likely explanation is that the company sold fixed assets during the year, eliminating the book-tax differe

28、nce relating to those assets. If those assets had a higher tax basis than book basis, sale would reduce the deferred tax asset by that difference multiplied by the tax rate. In 1999, the difference is smaller and in the right direction, since we have an expected $7.1 million increase due to write-do

29、wns and a reported increase of $8.9 million. Regardless of whether internal-use software was capitalized on the tax return, its write-off should generate a deferred tax debit. This difference is probably due to a combination of current year depreciation (reducing the deferred tax asset) and asset sa

30、les (increasing the deferred tax asset).In 2000, instead of an increase of $9.3 million, the company reports a decrease of $11.6 million in deferred tax assets. As for 1998, asset sales provide the most likely explanation. 8.Ma. (i) Income tax expense is lower than it would be if SGI provided taxes

31、on the undistributed earnings of its foreign subsidiaries. (ii) Income tax paid was not affected because those earnings are undistributed, that is, SGI did not pay U.S. income tax on them. (iii)The effective tax rate is lower than it would have been because income tax expense is lower (see answer a(i).(iv) Earnings per share are higher because income tax expense is lower.(v) Book value per share is higher because retained earnings (and therefore, equity) are higher. b. In the year that the foreign subsidiaries remitted previously undistributed earnings:(i) Pretax income wou