During the meeting in the afternoon, you ask Knepp and Lopez if there were perma
ID: 2754545 • Letter: D
Question
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.
A.) 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 deffered tax asset if Connor and Martin believe that the future benefits from the deffered tax asset probably will not be realized.
B.) Also include in the Backgorund section of the memo to Conner and Martin an explanation of how there might be the potential for earnings management when recording valuation allowancs for deffered tax assets
Explanation / Answer
Temporary differences are those which are likely o reverse in future, thus giving rise to deferred tax asset or deferred tax liablities
The following are the treatment
Insurance premium = 80000, no differences , deductible in both income and tax statement
Depreciation = 30000, Temporary difference, will give rise to deferref tax liabliity
Warranty expenses = 100000 * 3/4 = 75000 is temporary difference, it gets recorded in income statement at 100000, and at 25000 in tax statement at cash basis. The 75000 gives rise to deferred tax asset.
The valuation allowance is made for deffered tax asset if they believe that the future benefits from the deffered tax asset probably will not be realized
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