Following are three problems/questions. Your answers should be in a Word document or a pdf document. You can cut and paste from Excel if necessary. Just be sure your work and your answer are clearly shown.

Problem A, Income Taxes (15 points)

Harms Way Company (HWC) provides you with the following information for the year ended October 31, 2020. Your assignment is to calculate income tax expense, income taxes payable, and deferred income tax assets/liabilities. The end result will be a journal entry to record all of that. In addition, you must calculate HWC's effective tax rate and reconciliation to the federal statutory rate of 21%. You can explain the difference in words, if you wish.

Information provided:

1. Income before tax, as shown on HWC's GAAP statement of income = $2,440,000

2. Depreciation calculated under GAAP = $300,000. Depreciation as will be shown on the tax return = $475,000.

3. Interest income on municipal bonds, which is not subject to federal income tax = $150,000.

4. Fines recorded and paid during the year to the EPA for environmental violations = $450,000. Fines are not tax deductible.

5. Meals and entertainment expenses recorded during the year = $375,000. Only one-half (50%) of those expenses may be deducted for tax purposes.

6. At the end of the fiscal year (in October 2020), HWC received a payment of $750,000 from a client for a product to be delivered in November 2020. Under the tax law, that payment is taxable when received, not when the product is delivered.

Your Assignment:

Calculate:

1. Income tax expense (GAAP).

2. Income taxes currently payable.

3. Deferred income taxes resulting from this year's operations.

Be sure to show your work, I give partial credit (full credit, too, of course), but I must be able to see how you calculated amounts used in your answer.

Problem B, Cash Flow (15 points)

CWH (unrelated to Problem A) provides you with comparative statements of financial position and some additional information. Using the indirect method, calculate cash flow from operating activities. Then as best you can, calculate cash inflow/outflow from Investing activities and from Financing activities (you'll need to make assumptions, you do not have complete information and it isn't available).

12/31/19 12/31/2020

Cash .................................................................. $ 5,000 $ 17,000

Accounts receivable .......................................... 35,000 45,000

Inventory ........................................................... 75,000 63,000

Total current assets ........................................... 115,000 125,000

Land .................................................................. 100,000 100,000

Buildings ........................................................... 5,000,000 5,000,000

Equipment ......................................................... 12,000,000 21,000,000

Accumulated Depreciation ................................ (4,000,000) (4,750,000)

Net PP&E .......................................................... 13,100,000 21,350,000

Patents ............................................................... 7,000,000 5,800,000

Total Assets ....................................................... $20,215,000 $27,275,000

Accounts payable .............................................. $ 21,000 $ 45,000

Accrued expenses .............................................. 25,000 60,000

Income taxes payable ........................................ 12,000 35,000

Total current liabilities ...................................... 58,000 140,000

Long term debt .................................................. 12,000,000 16,000,000

Common stock .................................................. 1,500,000 2,000,000

Retained earnings .............................................. 6,657,000 9,135,000

Total Liabilities and Equity .............................. $20,215,000 $27,275,000

[NOTE: I have posted an Excel spreadsheet with the above information for your use, if you wish. If you do that, please just cut and paste a copy into your word submission. Make sure it's readable, probably need to format the page as landscape format, not portrait.]

Additional information provided:

• ? Net income = $2,600,000
• ? Dividends were declared and paid during the year.
• ? Depreciation expense = $750,000
• ? Make reasonable assumptions as need be.

Required:

1. Calculate cash flow from operating activities, showing your complete calculation. The number alone is not sufficient.

2. Calculate cash provided by/used in investing activities (you'll need to make some assumptions).

3. Calculate cash provided by /used in financing activities (again, you'll need to make some assumptions)

4. Show that the sum of the three cash flow numbers is equal to the change in cash.

Problem C, Contingencies (5 points)

Z Corp. filed a claim for patent infringement against M Corp. in October 2020. In preparing its financial statements for the year ending December 31, 2020, M Corp. financial accounting group obtained the following information related to this claim:

• ? M Corp's Risk Management Department believes that M will incur a loss from this lawsuit. They estimate the loss will be in a range from $15 million to $20 million, but cannot give a more precise estimate.
• ? The trial will likely not take place for two years, in 2022 or 2023.
• ? M Corp's CFO insists that the company will fight this claim "until the end of time." Based on that, the CFO maintains that no loss need be recorded because none will be incurred ... ever!
• ? M Corp's legal department believes the case will be resolved within four years, if appeals are necessary. They agree with Risk Management's assessment.

Your Assignment

Assume that you are the Controller of M Corp (you are the top accounting officer and report directly to the CFO). What do you say to the CFO about this matter? You must resolve this issue now so that financial statements can be prepared. You can literally write what you would say, or you can do it in the form of a brief message. But you must state your opinion on how this should be handled (not forgetting that your boss thinks nothing needs to be done). And it must be brief (the CFO does not like to read long messages ... get to the point!).

2,018 2,019 Cash 5,000 17,000 A/R 35,000 45,000 Inventory 75,000 63,000 Total current assets 115,000 125,000 Land 100,000 100,000 Bldgs 5,000,000 5,000,000 Equip 12,000,000 21,000,000 Accum Depr (4,000,000) (4,750,000) Net PP&E 13,100,000 21,350,000 Patents 7,000,000 5,800,000 Total Assets 20,215,000 27,275,000 AP 21,000 45,000 Accrued exp 25,000 60,000 Tax pay 12,000 35,000 Total Curr Liabilities 58,000 140,000 LTD 12,000,000 16,000,000 Common stock 1,500,000 2,000,000 Retained earnings 6,657,000 9,135,000 Total liabilities and equity 20,215,000 27,275,000