You have been hired as a consultant to advise on how to present the tax differences between books and tax returns on the balance sheet of RFH company. There are a few questionable items which the current controller Mary Sims is confused as to proper presentation. The timing differences are 1) $1,5000,000 as a result of depreciation timing difference (books S-L versus MACRS tax return). 2) There also was a bad debt reserve increase from the prior year of $250,000. RFH Company is a manufacturing company who accrued $300,000 in warranty liability at year-end and could not deduct it on the tax return for this year but warranty will be paid out in the following year. A lawsuit in the amount of $450,000 was accrued on the books at year-end awaiting the final legal court judgment. Prior court cases have ruled that this $500,000 can be paid evenly over 3 years. You have to write a memo to Mary Sims advising her how to classify these temporary tax differences on her books at year-end. In your memo give FASB sources for her that validates your balance sheet presentation.

Research Memorandum CEO, CFO, and Controller of XYZ Research Company, Inc. To: From: Nathan Ellery, Research Analyst Date: August 22, 2013 RE: Accounting for Patents Facts: XYZ Research Company, incorporated in 2010, develops new technology for interplanetary exploration. The company holds many patents, and has historically expensed the costs associated with the patents. Issues: 1. How are patents accounted for according to GAAP? 2. What is impairment testing, and does it apply to the patents held by XYZ Research Company? 3. Can a company capitalize their patents? 4. Are there any unique situations or exclusions for the industry (technology, or interplanetary exploration), in regards to accounting methods? 5. What corrective action, if any, is recommended to correct any misstatements made with regard to their patents? Authorities on Accounting for Patents (Intangible Assets): ASC 350-30-45-1 states that at a minimum, all intangible assets shall be aggregated and presented as a separate line item in the statement of financial position. However, that requirement does not preclude presentation of individual intangible assets or classes of intangible assets as separate line items. ASC 350-30-45-2 states that the amortization expense and impairment losses for intangible assets shall be presented in income statement line items within continuing operations as deemed appropriate for each entity. ASC 350-30-35-1 states that the accounting for a recognized intangible asset is based on its useful life to the reporting entity. An intangible asset with a finite useful life shall be amortized; an intangible asset with an indefinite useful life shall not be amortized. ASC 350-30-35-2 states that the useful life of an intangible asset to an entity is the period over which the asset is expected to contribute directly or indirectly to the future cash flows of that entity. ASC 350-30-35-15 states that if an intangible asset is determined to have an indefinite useful life, it shall not be amortized until its useful life is determined to be no longer indefinite. ASC 350-30-35-16 states that an entity shall evaluate the remaining useful life of an intangible asset that is not being amortized each reporting period to determine whether events and circumstances continue to support an indefinite useful life. ASC 350-30-35-17 states that if an intangible asset that is not being amortized is subsequently determined to have a finite useful life, the asset shall be tested for impairment in accordance with paragraphs 350-30-35-18 through 35-19. That intangible asset shall then be amortized prospectively over its estimated remaining useful life and accounted for in the same manner as other intangible assets that are subject to amortization. ASC 350-30-35-18 states that an intangible asset that is not subject to amortization shall be tested for impairment annually and more frequently if events or changes in circumstances indicate that it is more likely than not that the asset is impaired. The impairment test shall consist of a comparison of the fair value of an intangible asset with its carrying amount. If the carrying amount of an intangible asset exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess. ASC 350-30-35-18B states that in assessing whether it is more likely than not that an indefinite-lived intangible asset is impaired, an entity shall assess all relevant events and circumstances that could affect the significant inputs used to determine the fair value of the indefinite-lived intangible asset. Examples of such events include the following: a. Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on future expected earnings and cash flows that could affect significant inputs used to determine the fair value of the indefinite-lived intangible asset. b. Financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods that could affect significant inputs used to determine the fair value of the indefinite-lived intangible asset. c. Legal, regulatory, contractual, political, business, or other factors, including asset-specific factors that could affect significant inputs used to determine the fair value of the indefinite-lived intangible asset. d. Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation that could affect significant inputs used to determine the fair value of the indefinite-lived intangible asset. e. Industry and market considerations such as deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics, or a change in the market for an entity's products or services due to the effects of obsolescence, demand, competition, or other economic factors that could affect significant inputs used to determine the fair value of the indefinite-lived intangible asset. f. Macroeconomic conditions such as deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets that could affect significant inputs used to determine the fair value of the indefinite-lived intangible asset. ASC 350-30-35-19 states that the quantitative impairment test for an indefinite-lived intangible asset shall consist of a comparison of the fair value of the asset with its carrying amount. If the carrying amount of the intangible asset exceeds its fair value, an entity shall recognize an impairment loss in an amount equal to that excess. After an impairment loss is recognized, the adjusted carrying amount of the intangible asset shall be its new accounting basis. ASC 350-30-35-21 states that separately recorded indefinite-lived intangible assets, whether acquired or internally developed, shall be combined into a single unit of accounting for purposes of testing impairment if they are operated as a single asset and, as such, are essentially inseparable from one another. ASC 350-30-35-22 states that determining whether several indefinite-lived intangible assets are essentially inseparable is a matter of judgment that depends on the relevant facts and circumstances. The indicators in paragraph 350-30-35-23 shall be considered in making that determination. None of the indicators shall be considered presumptive or determinative. ASC 350-30-35-26 states that all of the following shall be included in the determination of the unit of accounting used to test indefinite-lived intangible assets for impairment: a. The unit of accounting shall include only indefinite-lived intangible assets - those assets cannot be tested in combination with goodwill or with a finitelived asset. b. The unit of accounting cannot represent a group of indefinite-lived intangible assets that collectively constitute a business or a non-profit activity. c. A unit of accounting may include indefinite-lived intangible assets recorded in the separate financial statements of consolidated subsidiaries. As a result, an impairment loss recognized in the consolidated financial statements may differ from the sum of the impairment losses (if any) recognized in the separate financial statements of those subsidiaries. d. If the unit of accounting used to test impairment of indefinite-lived intangible assets is contained in a single reporting unit, the same unit of accounting and associated fair value shall be used for purposes of measuring a goodwill impairment loss in accordance with paragraphs 350-20-35-9 through 35-18. ASC 740-10-55-34 states that an operating loss, certain deductible items that are subject to limitations, and some tax credits arising but not utilized in the current year may be carried back for refund of taxes paid in prior years or carried forward to reduce taxes payable in future years. A receivable, to the extent it meets the recognition requirements of the Subtopic for tax positions, is recognized for the amount of taxes paid in prior years that is refundable by carryback of an operating loss or unused tax credits of the current year. ASC 740-10-55-38 states that except as noted in paragraph 740-20-45-3, the manner of reporting the tax benefit of an operating loss carryforward or carryback is determined by the source of the income or loss in the current year and not by the source of the operating loss carryforward or taxes paid in a prior year or the source of expected future income that will result in realization of a deferred tax asset for an operating loss carryforward from the current year. Deferred tax expense (or benefit) that results because a change in circumstances causes a change in judgment about the future realization of the tax benefit of an operating loss carryforward is allocated to continuing operations. ASC 740-10-55-39 states that expectations about future taxable income incorporate numerous assumptions about actions, elections, and strategies to minimize income taxes in future years. For example, an entity may have a practice of deferring taxable income whenever possible by structuring sales to qualify as installment sales for tax purposes. Actions such as that are not tax-planning strategies, as that term is used in this Topic because they are actions that management takes in the normal course of business. For purposes of applying the requirements of this Subtopic, a tax-planning strategy is an action that management ordinarily might not take but would take, if necessary, to realize a tax benefit for a carryforward before it expires. For example, a strategy to sell property and lease it back for the expressed purpose of generating taxable income to utilize a carryforward before it expires is not an action that management takes in the normal course of business. A qualifying tax-planning strategy is an action that: a. Is prudent and feasible. Management must have the ability to implement the strategy and expect to do so unless the need is eliminated in future years. For example, management would not have to apply the strategy if income earned in a later year uses the entire amount of carryforward from the current year. b. An entity ordinarily might not take, but would take to prevent an operating loss or tax credit carryforward from expiring unused. All of the various strategies that are expected to be employed for business or tax purposes other than utilization of carryforwards that would otherwise expire unused are, for purposes of this Subtopic, implicit in management's estimate of future taxable income and, therefore, are not tax-planning strategies as that term is used in the Topic. c. Would result in realization of deferred tax assets. The effect of qualifying taxplanning strategies must be recognized in the determination of the amount of a valuation allowance. Tax-planning strategies need to be considered, however, if positive evidence available from other sources (see paragraph 740-10-3018) is sufficient to support a conclusion that a valuation allowance is not necessary. Conclusion: XYZ Research Company Inc. will need to apply the research provided to their accounting practices to properly account for their patents (intangible assets). Impairment testing needs to be done for their patents during the course of the year to determine, if any, there is an impairment loss. XYZ will also need to determine the useful life, if any, for each of their current and future patents. Recommendations: This researcher recommends that the XYZ Research Company read carefully the rules and regulations under the Financial Accounting Standards Board (FASB) to ensure that they are in full compliance with the Generally Accepted Accounting Practices (GAAP). If they find that, through adjusted accounting practices, that the XYZ Research Company is entitled to a tax benefit, then the company should consider filing an amended tax return. To help support these findings, the XYZ Research Company should investigate and gather all relevant data and files pertaining to their patents. This will help the company support their claims if they choose to file an amended tax return with the Internal Revenue Service (IRS). Carl n Carl Auditors 1 Floor, AB Towers, NW Avenue, Road 6. Street 9, Chicago USA st Date-07.02.2014 To - CEO, CFO, and Mary Sims, of RFH Company, Inc. From - Barbara Carlos, Consultant Subject - Advise on how to present the tax differences between books and tax returns on the balance sheet Reason - It is not properly presented in books of accounts and there is the timing differences in few calculations. Issues - 1) $1,5000,000 as a result of depreciation timing difference (books S-L versus MACRS tax return). 2) There also was a bad debt reserve increase from the prior year of $250,000. Authorities on Procedures We have audited the attached Balance Sheet of RFH Company as the 31st December 2013 and also the Profit and Loss account for the year ended on that day annexed thereto. These financial statements are the responsibility of the entity's management. Our responsibility is to express an opinion on these financial statements based on our audit. (a) ASC 740 Balance Sheet Approach to Taxes ,Timing differences between book basis and tax basis, Does not impact total tax expense or ETR (b) Recognizing deferred tax assets and liabilities for tax purposes, a firm would choose MACRS because it provides for larger depreciation deductions earlier. These larger deductions reduce taxes, but have no other cash consequences. Notice that the choice between MACRS and straight-line is purely a time value issue; the total depreciation is the same, only the timing differs. (C)Depreciation is a non-cash expense, but it is tax-deductible on the income statement. Thus depreciation causes taxes paid, an actual cash outflow, to be reduced by an amount equal to the depreciation tax shield tcD. A reduction in taxes that would otherwise be paid is the same thing as a cash inflow, so the effects of the depreciation tax shield must be added in to get the total incremental aftertax cash flows. (D) ASC 740 Bad Debt Reserve - Initial reserve for books is $2,500,000 Allowed reserve for tax is $150,000 Unfavorable Tax adjustment = $1,850,000 disallowed deduction (or additional income) Deferred component = $1,850,000 Book Reserve > Tax Reserve = Deferred Tax Asset (E) Accrued $300,000 in warranty liability at year-end and could not deduct it on the tax return for this year but warranty will be paid out in the following year. A lawsuit in the amount of $450,000 was accrued on the books at year-end awaiting the final legal court judgment. Prior court cases have ruled that this $500,000 can be paid evenly over 3 years. ASC 740-10-55-34 states that an operating loss, certain deductible items that are subject to limitations, and some tax credits arising but not utilized in the current year may be carried back for refund of taxes paid in prior years or carried forward to reduce taxes payable in future years. ASC 740-10-55-38 states that except as noted in paragraph 740-20-45-3, the manner of reporting the tax benefit of an operating loss carryforward or carryback is determined by the source of the income or loss in the current year and not by the source of the operating loss carryforward or taxes paid in a prior year or the source of expected future income that will result in realization of a deferred tax asset for an operating loss carryforward from the current year. Deferred tax expense (or benefit) that results because a change in circumstances causes a change in judgment about the future realization of the tax benefit of an operating loss carryforward is allocated to continuing operations. A qualifying tax-planning strategy is an action that: Is prudent and feasible. Management must have the ability to implement the strategy and expect to do so unless the need is eliminated in future years. For example, management would not have to apply the strategy if income earned in a later year uses the entire amount of carryforward from the current year. An entity ordinarily might not take, but would take to prevent an operating loss or tax credit carryforward from expiring unused. All of the various strategies that are expected to be employed for business or tax purposes other than utilization of carryforwards that would otherwise expire unused are, for purposes of this Subtopic, implicit in management's estimate of future taxable income and, therefore, are not tax-planning strategies as that term is used in the Topic. Would result in realization of deferred tax assets. The effect of qualifying tax-planning strategies must be recognized in the determination of the amount of a valuation allowance. Tax-planning strategies need to be considered, that a valuation allowance is not necessary. Conclusion: RFH Company need to apply various strategies that are expected to be employed for business or tax purposes other than utilization of carryforwards that would otherwise expire unused are, for purposes of this Subtopic, implicit in management's estimate of future taxable income and, therefore, are not tax-planning strategies Recommendations: This researcher recommends that the RFH Company read carefully the rules and regulations under the Financial Accounting Standards Board (FASB) to ensure that they are in full compliance with the Generally Accepted Accounting Practices (GAAP). If they find that, through adjusted accounting practices, that the RFH Company is entitled to a tax benefit, then the company should consider filing an amended tax return. For purposes of applying the requirements, a tax-planning strategy is an action that management ordinarily might not take but would take, if necessary, to realize a tax benefit for a carryforward before it expires. For Carl n Carl Auditors, AUDITORS Place of Signature Date