Can you explain step by step on how to solve chapter 19?
Chapter 19 Accounting in Action: CM2 When you arrive at CM2 for the afternoon, Conner and Martin are arguing with Lopez and Knepp about, of all things, the corporate income taxes. As you walk in, you hear Conner saying, "there's no way I'm putting a valuation allowance on the deferred tax asset." Knepp is concerned that it will be misleading if it turns out that the company cannot benefit from the deferred tax asset in the future, but has not looked at the exact US GAAP rules since taking an Intermediate Accounting class. Knepp knows that Conner and Martin are planning to increase research and development substantially in 2014 and 2015 and project there will be losses before taxes of roughly $200,000 in each of those years until the Company can return to profitability in 2016 and benefit from the R&D. During the meeting in the afternoon, you ask Knepp and Lopez if there were any temporary differences in 2013 as you do not see a deferred tax asset recorded on the preliminary balance sheet yet. They responded that they were not aware of any differences for 2013. However, Knepp tells you that depreciation expense recorded for tax will be $30,000 higher than that recorded for the books. That is, the book value of the fixed assets for GAAP will be $30,000 higher compared to their book value reported on the tax return. Knepp then mentions that CM2 will begin offering a six-month warranty on its RFID product in 2013. The forecasted income statement includes estimated warranty expense accrual of $100,000; one-fourth of this amount will be settled in 2013 through actual claims being filed. You remember from your Continuing Case 1 Intermediate Accounting class that for tax purposes, only the cash expense incurred in doing the work is deductible. Also, the allowance for doubtful accounts is estimated to be $119,000 at the end of 2013. You believe that these three items may be part of a deferred tax calculation but you have to refresh your recollection by looking back at your intermediate accounting textbook. Instructions (a) Using the Excel file of the financial statements of CM2 for 2013 and 2012 and the FASB Codification (access is provided in course Resources in Blackboard), write a memo that you can take to Conner and Martin to analyze the factors that indicate whether a valuation allowance is necessary, and apply each to CM2. Draw a conclusion as to whether a valuation allowance should be recorded at the end of 2013. As part of the memo, you will have to first determine what the net deferred tax asset will be at the end of 2013. [For simplicity, assume that all deferred tax items are current, and that the Company will book either book a full allowance or not book any allowance at allignore the possibility of recording a partial allowance.] The memo should be in good form, meaning it should have clearly marked sections that describe the: a. Purpose of the memo in a sentence, the b. Background facts, the c. sections of the Guidance that is relevant and which will be quoted, Continuing Case 2 d. an Analysis of the guidance against the facts by going through the relevant guidance section by section (or paragraph by paragraph), and then a e. Conclusion. (b) During the meeting in the afternoon, you ask Knepp and Lopez if there were permanent or temporary differences in 2012 and whether they will continue into 2013. They responded that they were not aware of any differences for either 2012 or 2013. However, in 2013 Conner and Martin were given life insurance policies. The insurance premium on these policies amounted to $80,000 per year. CM2 also anticipates investing in local county bonds which should earn about $7,000 investment income in 2013. Both of these items are reported on the forecasted income statement. In addition, Knepp tells you that depreciation expense recorded for tax will be $30,000 higher than that recorded for the books. That is, the book value of the fixed assets for GAAP will be $30,000 higher compared to their book value reported on the tax return. Knepp then mentions that CM2 will begin offering a six-month warranty on its RFID product. The forecasted income statement includes estimated warranty expense accrual of $100,000; one-fourth of this amount will be settled in 2013 through actual claims being filed. You remember from your Intermediate Accounting class that for tax purposes, only the cash expense incurred in doing the work is deductible. Continuing Case 3 (b) The memo should include in the Background section a description of the entry that would be made if a valuation allowance must be recorded against the deferred tax asset if Conner and Martin believe that the future benefits from the deferred tax asset probably will not be realized. (c) Also include in the Background section of the memo to Conner and Martin an explanation of how there might be the potential for earnings management when recording valuation allowances for deferred tax assets. Continuing Case 4 Chapter 21 Accounting in Action: CM2 Earlier, Conner and Martin had asked you to analyze four proposals for acquiring a very expensive, very large piece of equipment using debt financing. None of the proposals they asked you to review involved leasing the new equipment. In light of concerns expressed about the potentially short period of time before new technology makes a machine obsolete, you are surprised that leasing was not considered. From what you remember, leasing provides some real benefits. The fair value of the new equipment is approximately $685,000 and is expected to have an economic life of eight years. When the possibility of leasing equipment is discussed, both Conner and Martin express much interest. They have had prior business dealings with Tyler Leasing Company, and the results have been satisfactory. You call Buzz Tyler and ask him about leasing the new equipment; the next day, he sends you the following proposal: Tyler Leasing Company would acquire the equipment and lease it to CM2. The lease payments would be $145,661 for five years, paid at the beginning of each period. CM2 would guarantee the residual value of $125,000 at the end of the lease period. The fair market value of similar equipment is $685,000. The implicit interest rate in this offer is 10%, which is also CM2 's borrowing rate. Conner and Martin like the proposal and want to know more about the benefits of leasing versus owning. Remember that their focus is to go to the bond Continuing Case 5 or equity market at the end of 2013. They do not want to guarantee the residual value, but Conner and Martin place a conference call with Buzz Tyler. He expresses his company's concern that they stand to lose a considerable amount if the equipment is run down when it is returned to them. Conner and Martin are also excited about the possibility of reporting only the rental expense on the income statement. In addition, they understand that they may not have to report a liability on the balance sheet, which makes them even happier. Instructions (a) Analyze the Tyler Leasing Company proposal. Write a memo using the format described in Chapter 19 above that shows Conner and Martin (and also Lopez and Knepp, since they appear to be slightly skeptical of this idea) the effect of the proposal on the company's balance sheet depending on whether the lease would be treated as an operating lease or a capital lease (ignore income taxes). The memo should go through the factors that determine whether the lease is an operating or capital lease and draw a conclusion as to which it would be. (b) Access file 4a on the website (Excel File) for information about the company's current debt and equity positions. In the background section of your memo explain the debt and equity relationships assuming the leasing proposal results in an operating lease versus a capital lease. If your analysis indicates the lease would be a capital lease, suggest how CM2 could negotiate the terms so that it meets the definition of an operating lease. Continuing Case 6 Chapter 22 Accounting in Action: CM2 Conner and Martin have appreciated your involvement in all aspects of the company's operations throughout the year. They now want you to take the accounting records over these past three years and give them advice on any errors and/or corrections you may find. You tell them this may take a while, and you ask if they can give you a few days to conduct your review. They agree. Access File 4a on the website (Excel File) containing CM2 's financial statements for 2011, 2012, and the forecasted trial balance and financials for 2013. After carefully examining three years of information, you come up with the following: (1) Ending inventory in 2011 was overstated by $32,000 as a result of errors in the inventory count-sheet footings. (2) Prepaid rent of $9,500 for 2013 was expensed at the end of 2012. (3) Depreciation was understated in 2011, 2012, and 2013. This was due to a piece of equipment costing $110,000 which was purchased in 2011 and was expected to have a five-year life and no residual value. Instead of using straight-line depreciation for the expense in 2011, the whole $110,000 was expensed. (4) Employee wages of $26,000, earned at the end of 2011, were not accrued but were expensed in 2012 when they were paid. Continuing Case 7 Instructions (a) Prepare a worksheet in a similar format to the one in Illustration 22-24 of the text. Ignore income taxes. (b) Write a memo in the format described for Chapter 19 above that clearly describes the purpose, background, relevant guidance, analyzes the guidance against the errors/misstatements above, and draws a conclusion on what Connor and Martin should do to present the 2011 through 2013 financial statements correctly. Continuing Case 8
