Chapter 21 d. all of these. d. All of these b. Leases similar to installment purchases are capitalized.

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1 Chapter 21 T1. Leasing equipment reduces the risk of obsolescence to the lessee, and passes the risk of residual value to the lessor. F2. The FASB agrees with the capitalization approach and requires companies to capitalize all long-term leases. F3. A lease that contains a purchase option must be capitalized by the lessee. T4. Executory costs should be excluded by the lessee in computing the present value of the minimum lease payments. F5. A capitalized leased asset is always depreciated over the term of the lease by the lessee. F6. A lessee records interest expense in both a capital lease and an operating lease. T7. A benefit of leasing to the lessor is the return of the leased property at the end of the lease term. F8. The distinction between a direct-financing lease and a sales-type lease is the presence or absence of a transfer of title. F9. Lessors classify and account for all leases that don t qualify as sales-type leases as operating leases. T10. Direct-financing leases are in substance the financing of an asset purchase by the lessee. F11. Under the operating method, the lessor records each rental receipt as part interest revenue and part rental revenue. F12. In computing the annual lease payments, the lessor deducts only a guaranteed residual value from the fair market value of a leased asset. T13. When the lessee agrees to make up any deficiency below a stated amount that the lessor realizes in residual value, that stated amount is the guaranteed residual value. F14. Both a guaranteed and an unguaranteed residual value affect the lessee s computation of amounts capitalized as a leased asset. T15. From the lessee s viewpoint, an unguaranteed residual value is the same as no residual value in terms of computing the minimum lease payments. F16. The lessor will recover a greater net investment if the residual value is guaranteed instead of unguaranteed. T17. The primary difference between a direct-financing lease and a sales-type lease is the manufacturer s or dealer s gross profit. F18. The gross profit amount in a sales-type lease is greater when a guaranteed residual value exists. Accounting for Leases T19. Companies must periodically review the estimated unguaranteed residual value in a sales-type lease. T20. The FASB requires lessees and lessors to disclose certain information about leases in their financial statements or in the notes. 21. Major reasons why a company may become involved in leasing to other companies is (are) d. all of these. 22. Which of the following is an advantage of leasing? d. All of these 23. Which of the following best describes current practice in accounting for leases? b. Leases similar to installment purchases are capitalized. 24. While only certain leases are currently accounted for as a sale or purchase, there is theoretic justification for considering all leases to be sales or purchases. The principal reason that supports this idea is that c. a lease reflects the purchase or sale of a quantifiable right to the use of property. S25. An essential element of a lease conveyance is that the a. lessor conveys less than his or her total interest in the property. S26. What impact does a bargain purchase option have on the present value of the minimum lease payments computed by the lessee? b. The lessee must increase the present value of the minimum lease payments by the present value of the option price.

2 P27. The amount to be recorded as the cost of an asset under capital lease is equal to the b. present value of the minimum lease payments or the fair value of the asset, whichever is lower. 28. The methods of accounting for a lease by the lessee are a. operating and capital lease methods. 29. Which of the following is a correct statement of one of the capitalization criteria? c. The lease term is equal to or more than 75% of the estimated economic life of the leased property. 30. Minimum lease payments may include a d. any of these. 31. Executory costs include d. all of these. 32. In computing the present value of the minimum lease payments, the lessee should c. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is lower, assuming that the implicit rate is known to the lessee. 33. In computing depreciation of a leased asset, the lessee should subtract a. a guaranteed residual value and depreciate over the term of the lease. 34. In the earlier years of a lease, from the lessee's perspective, the use of the b. capital method will cause debt to increase, compared to the operating method. P35. A lessee with a capital lease containing a bargain purchase option should depreciate the leased asset over the a. asset's remaining economic life. 36. Based solely upon the following sets of circumstances indicated below, which set gives rise to a sales-type or direct-financing lease of a lessor? Transfers Ownership Contains Bargain Collectibility of Lease Any Important By End Of Lease? Purchase Option? Payments Assured? Uncertainties? a. No Yes Yes No 37. Which of the following would not be included in the Lease Receivable account? d. All would be included 38. In a lease that is appropriately recorded as a direct-financing lease by the lessor, unearned income a. should be amortized over the period of the lease using the interest method. S39. In order to properly record a direct-financing lease, the lessor needs to know how to calculate the lease receivable. The lease receivable in a direct-financing lease is best defined as c. the present value of minimum lease payments. S40. If the residual value of a leased asset is guaranteed by a third party d. it is treated by the lessee as an additional payment and by the lessor as realized at the end of the lease term. S41. The primary difference between a direct-financing lease and a sales-type lease is the c. recognition of the manufacturer's or dealer's profit at the inception of the lease. P42. A lessor with a sales-type lease involving an unguaranteed residual value available to the lessor at the end of the lease term will report sales revenue in the period of inception of the lease at which of the following amounts? b. The present value of the minimum lease payments. 43. For a sales-type lease, c. the gross profit will be the same whether the residual value is guaranteed or unguaranteed. 44. Which of the following statements is correct? d. All of these. 45. The Lease Liability account should be disclosed as c. current portions in current liabilities and the remainder in noncurrent liabilities. *46. When a company sells property and then leases it back, any gain on the sale should usually be d. deferred and recognized as income over the term of the lease.

3 47. On December 1, 2008, Perez Corporation leased office space for 10 years at a monthly rental of $90,000. On that date Perez paid the landlord the following amounts: Rent deposit $ 90,000 First month's rent 90,000 Last month's rent 90,000 Installation of new walls and offices 495,000 $765,000 The entire amount of $765,000 was charged to rent expense in What amount should Perez have charged to expense for the year ended December 31, 2008? b. $94, On January 1, 2008, Penn Corporation signed a ten-year noncancelable lease for certain machinery. The terms of the lease called for Penn to make annual payments of $100,000 at the end of each year for ten years with title to pass to Penn at the end of this period. The machinery has an estimated useful life of 15 years and no salvage value. Penn uses the straight-line method of depreciation for all of its fixed assets. Penn accordingly accounted for this lease transaction as a capital lease. The lease payments were determined to have a present value of $671,008 at an effective interest rate of 8%. With respect to this capitalized lease, Penn should record for 2008 c. interest expense of $53,681 and depreciation expense of $44,734. Use the following information for questions 49 through 54. (Annuity tables on page ) On January 1, 2008, Dexter, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Garr Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement. (a) The agreement requires equal rental payments at the end of each year. (b) The fair value of the building on January 1, 2008 is $3,000,000; however, the book value to Garr is $2,500,000. (c) The building has an estimated economic life of 10 years, with no residual value. Dexter depreciates similar buildings on the straight-line method. (d) At the termination of the lease, the title to the building will be transferred to the lessee. (e) Dexter's incremental borrowing rate is 11% per year. Garr Warehouse Co. set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is known by Dexter, Inc. (f) The yearly rental payment includes $10,000 of executory costs related to taxes on the property. 49. What is the amount of the minimum annual lease payment? (Rounded to the nearest dollar.) c. $488, What is the amount of the total annual lease payment? d. $498, From the lessor's viewpoint, what type of lease is involved? a. Sales-type lease 52. From the lessee's viewpoint, what type of lease exists in this case? c. Capital lease 53. Dexter, Inc. would record depreciation expense on this storage building in 2008 of (Rounded to the nearest dollar.) c. $300, If the lease were nonrenewable, there was no purchase option, title to the building does not pass to the lessee at termination of the lease and the lease were only for eight years, what type of lease would this be for the lessee? d. Capital lease 55. Huffman Company leases a machine from Lincoln Corp. under an agreement which meets the criteria to be a capital lease for Huffman. The six-year lease requires payment of $102,000 at the beginning of each year, including $15,000 per year for maintenance, insurance, and taxes. The incremental borrowing rate for the lessee is 10%; the lessor's

4 implicit rate is 8% and is known by the lessee. The present value of an annuity due of 1 for six years at 10% is The present value of an annuity due of 1 for six years at 8% is Huffman should record the leased asset at c. $434, On December 31, 2007, Pool Corporation leased a ship from Renn Company for an eightyear period expiring December 30, Equal annual payments of $200,000 are due on December 31 of each year, beginning with December 31, The lease is properly classified as a capital lease on Pool's books. The present value at December 31, 2007 of the eight lease payments over the lease term discounted at 10% is $1,173,685. Assuming all payments are made on time, the amount that should be reported by Pool Corporation as the total obligation under capital leases on its December 31, 2008 balance sheet is c. $871,054. Use the following information for questions 57 and 58. On January 1, 2008, Dalton Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Dalton to make annual payments of $50,000 at the beginning of each year for five years with title to pass to Dalton at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Dalton uses the straight-line method of depreciation for all of its fixed assets. Dalton accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $208,493 at an effective interest rate of 10%. 57. In 2008, Dalton should record interest expense of a. $15, In 2009, Dalton should record interest expense of b. $12, On December 31, 2008, Dodd Corporation leased a plane from Aero Company for an eight-year period expiring December 30, Equal annual payments of $150,000 are due on December 31 of each year, beginning with December 31, The lease is properly classified as a capital lease on Dodd s books. The present value at December 31, 2008 of the eight lease payments over the lease term discounted at 10% is $880,264. Assuming the first payment is made on time, the amount that should be reported by Dodd Corporation as the lease liability on its December 31, 2008 balance sheet is d. $730,264. Use the following information for questions 60 and 61. On January 1, 2008, Carley Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Carley to make annual payments of $60,000 at the end of each year for five years with title to pass to Carley at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Carley uses the straight-line method of depreciation for all of its fixed assets. Carley accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $227,448 at an effective interest rate of 10%. 60. With respect to this capitalized lease, for 2008 Carley should record c. interest expense of $22,745 and depreciation expense of $32, With respect to this capitalized lease, for 2009 Carley should record c. interest expense of $19,019 and depreciation expense of $32, Barkley Corporation is a lessee with a capital lease. The asset is recorded at $450,000 and has an economic life of 8 years. The lease term is 5 years. The asset is expected to have a market value of $150,000 at the end of 5 years, and a market value of $50,000 at the end of 8 years. The lease agreement provides for the transfer of title of the asset to the lessee at the end of the lease term. What amount of depreciation expense would the lessee record for the first year of the lease? d. $50,000 Use the following information for questions 63 through 68. (Annuity tables on page ) Hay Corporation enters into an agreement with Marly Rentals Co. on January 1, 2008 for the purpose of leasing a machine to be used in its manufacturing operations. The following data pertain to the agreement: (a) The term of the noncancelable lease is 3 years with no renewal option. Payments of

5 $155,213 are due on December 31 of each year. (b) The fair value of the machine on January 1, 2008, is $400,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease. (c) Hay depreciates all machinery it owns on a straight-line basis. (d) Hay's incremental borrowing rate is 10% per year. Hay does not have knowledge of the 8% implicit rate used by Marly. (e) Immediately after signing the lease, Marly finds out that Hay Corp. is the defendant in a suit which is sufficiently material to make collectibility of future lease payments doubtful. 63. What type of lease is this from Hay Corporation's viewpoint? b. Capital lease 64. If Hay accounts for the lease as an operating lease, what expenses will be recorded as a consequence of the lease during the fiscal year ended December 31, 2008? b. Rent Expense 65. If the present value of the future lease payments is $400,000 at January 1, 2008, what is the amount of the reduction in the lease liability for Hay Corp. in the second full year of the lease if Hay Corp. accounts for the lease as a capital lease? (Rounded to the nearest dollar.) c. $126, From the viewpoint of Marly, what type of lease agreement exists? a. Operating lease 67. If Marly records this lease as a direct-financing lease, what amount would be recorded as Lease Receivable at the inception of the lease? c. $400, Which of the following lease-related revenue and expense items would be recorded by Marly if the lease is accounted for as an operating lease? d. Rental Revenue and Depreciation Expense 69. Sele Company leased equipment to Snead Company on July 1, 2007, for a one-year period expiring June 30, 2008, for $60,000 a month. On July 1, 2008, Sele leased this piece of equipment to Quirk Company for a three-year period expiring June 30, 2011, for $75,000 a month. The original cost of the equipment was $4,800,000. The equipment, which has been continually on lease since July 1, 2003, is being depreciated on a straightline basis over an eight-year period with no salvage value. Assuming that both the lease to Snead and the lease to Quirk are appropriately recorded as operating leases for accounting purposes, what is the amount of income (expense) before income taxes that each would record as a result of the above facts for the year ended December 31, 2008? Sele Snead Quirk a. $210,000 $(360,000) $(450,000) Use the following information for questions 70 and 71. Eddy leased equipment to Hoyle Company on May 1, At that time the collectibility of the minimum lease payments was not reasonably predictable. The lease expires on May 1, Hoyle could have bought the equipment from Eddy for $3,200,000 instead of leasing it. Eddy's accounting records showed a book value for the equipment on May 1, 2008, of $2,800,000. Eddy's depreciation on the equipment in 2008 was $360,000. During 2008, Hoyle paid $720,000 in rentals to Eddy for the 8-month period. Eddy incurred maintenance and other related costs under the terms of the lease of $64,000 in After the lease with Hoyle expires, Eddy will lease the equipment to another company for two years. 70. Ignoring income taxes, the amount of expense incurred by Hoyle from this lease for the year ended December 31, 2008, should be d. $720, The income before income taxes derived by Eddy from this lease for the year ended December 31, 2008, should be a. $296, Hite Company has a machine with a cost of $400,000 which also is its fair market value on the date the machine is leased to Rich Company. The lease is for 6 years and the machine is estimated to have an unguaranteed residual value of $40,000. If the lessor's

6 interest rate implicit in the lease is 12%, the six beginning-of-the-year lease payments would be b. $82, Estes Co. leased a machine to Dains Co. Assume the lease payments were made on the basis that the residual value was guaranteed and Estes gets to recognize all the profits, and at the end of the lease term, before the lessee transfers the asset to the lessor, the leased asset and obligation accounts have the following balances: Leased equipment under capital lease $400,000 Less accumulated depreciation--capital lease 384,000 $ 16,000 Interest payable $ 1,520 Obligations under capital leases 14,480 $16,000 If, at the end of the lease, the fair market value of the residual value is $8,800, what gain or loss should Estes record? c. $7,200 loss 74. Durham Company leased machinery to Santi Company on July 1, 2008, for a ten-year period expiring June 30, Equal annual payments under the lease are $75,000 and are due on July 1 of each year. The first payment was made on July 1, The rate of interest used by Durham and Santi is 9%. The cash selling price of the machinery is $525,000 and the cost of the machinery on Durham's accounting records was $465,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Durham, what amount of interest revenue would Durham record for the year ended December 31, 2008? c. $20, Eby Company leased equipment to the Mills Company on July 1, 2008, for a ten-year period expiring June 30, Equal annual payments under the lease are $80,000 and are due on July 1 of each year. The first payment was made on July 1, The rate of interest contemplated by Eby and Mills is 9%. The cash selling price of the equipment is $560,000 and the cost of the equipment on Eby's accounting records was $496,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Eby, what is the amount of profit on the sale and the interest revenue that Eby would record for the year ended December 31, 2008? c. $64,000 and $21,600 Use the following information for questions 76 and 77. Risen Company, a dealer in machinery and equipment, leased equipment to Foran, Inc., on July 1, The lease is appropriately accounted for as a sale by Risen and as a purchase by Foran. The lease is for a 10-year period (the useful life of the asset) expiring June 30, The first of 10 equal annual payments of $621,000 was made on July 1, Risen had purchased the equipment for $3,900,000 on January 1, 2008, and established a list selling price of $5,400,000 on the equipment. Assume that the present value at July 1, 2008, of the rent payments over the lease term discounted at 8% (the appropriate interest rate) was $4,500, Assuming that Foran, Inc. uses straight-line depreciation, what is the amount of depreciation and interest expense that Foran should record for the year ended December 31, 2008? a. $225,000 and $155, What is the amount of profit on the sale and the amount of interest income that Risen should record for the year ended December 31, 2008? b. $600,000 and $155, Mayer Company leased equipment from Lennon Company on July 1, 2008, for an eightyear period expiring June 30, Equal annual payments under the lease are $300,000 and are due on July 1 of each year. The first payment was made on July 1, The rate of interest contemplated by Mayer and Lennon is 8%. The cash selling price of the equipment is $1,861,875 and the cost of the equipment on Lennon's accounting records was $1,650,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Lennon, what is the amount of profit on the sale and the interest

7 income that Lennon would record for the year ended December 31, 2008? c. $211,875 and $62,475 Use the following information for questions 79 through 83. Bohl Co. purchases land and constructs a service station and car wash for a total of $360,000. At January 2, 2007, when construction is completed, the facility and land on which it was constructed are sold to a major oil company for $400,000 and immediately leased from the oil company by Bohl. Fair value of the land at time of the sale was $40,000. The lease is a 10-year, noncancelable lease. Bohl uses straight-line depreciation for its other various business holdings. The economic life of the facility is 15 years with zero salvage value. Title to the facility and land will pass to Bohl at termination of the lease. A partial amortization schedule for this lease is as follows: Payments Interes t Amortization Balance Jan. 2, 2007 $400, Dec. 31, 2007 $65, $40, $25, , Dec. 31, , , , , Dec. 31, , , , , From the viewpoint of the lessor, what type of lease is involved above? c. Direct-financing lease 80. What is the discount rate implicit in the amortization schedule presented above? b. 10% 81. The total lease-related expenses recognized by the lessee during 2008 is which of the following? (Rounded to the nearest dollar.) d. $61, What is the amount of the lessee's liability to the lessor after the December 31, 2009 payment? (Rounded to the nearest dollar.) d. $316,925 *83. The total lease-related income recognized by the lessee during 2008 is which of the following? b. $2,667 *84. On June 30, 2008, Colt sold equipment to an unaffiliated company for $700,000. The equipment had a book value of $630,000 and a remaining useful life of 10 years. That same day, Colt leased back the equipment at $7,000 per month for 5 years with no option to renew the lease or repurchase the equipment. Colt's rent expense for this equipment for the year ended December 31, 2008, should be b. $42, Lease A does not contain a bargain purchase option, but the lease term is equal to 90 percent of the estimated economic life of the leased property. Lease B does not transfer ownership of the property to the lessee by the end of the lease term, but the lease term is equal to 75 percent of the estimated economic life of the leased property. How should the lessee classify these leases? Lease A Lease B c. Capital lease Capital lease 86. On December 31, 2008, Mendez, Inc. leased machinery with a fair value of $840,000 from Cey Rentals Co. The agreement is a six-year noncancelable lease requiring annual payments of $160,000 beginning December 31, The lease is appropriately accounted for by Mendez as a capital lease. Mendez's incremental borrowing rate is 11%. Mendez knows the interest rate implicit in the lease payments is 10%. The present value of an annuity due of 1 for 6 years at 10% is The present value of an annuity due of 1 for 6 years at 11% is In its December 31, 2008 balance sheet, Mendez should report a lease liability of a. $606, On December 31, 2007, Patten Co. leased a machine from Bass, Inc. for a five-year period. Equal annual payments under the lease are $630,000 (including $30,000 annual executory costs) and are due on December 31 of each year. The first payment was made on December 31, 2007, and the second payment was made on December 31, The five lease payments are discounted at 10% over the lease term. The present value of

8 minimum lease payments at the inception of the lease and before the first annual payment was $2,502,000. The lease is appropriately accounted for as a capital lease by Patten. In its December 31, 2008 balance sheet, Patten should report a lease liability of d. $1,492, A lessee had a ten-year capital lease requiring equal annual payments. The reduction of the lease liability in year 2 should equal a. the current liability shown for the lease at the end of year 1. Use the following information for questions 89 and 90. On January 2, 2008, Martinez, Inc. signed a ten-year noncancelable lease for a heavy duty drill press. The lease stipulated annual payments of $150,000 starting at the end of the first year, with title passing to Martinez at the expiration of the lease. Martinez treated this transaction as a capital lease. The drill press has an estimated useful life of 15 years, with no salvage value. Martinez uses straight-line depreciation for all of its plant assets. Aggregate lease payments were determined to have a present value of $900,000, based on implicit interest of 10%. 89. In its 2008 income statement, what amount of interest expense should Martinez report from this lease transaction? d. $90, In its 2008 income statement, what amount of depreciation expense should Martinez report from this lease transaction? d. $60, In a lease that is recorded as a sales-type lease by the lessor, interest revenue c. should be recognized over the period of the lease using the effective interest method. 92. Castro Co. manufactures equipment that is sold or leased. On December 31, 2008, Castro leased equipment to Ermler for a five-year period ending December 31, 2013, at which date ownership of the leased asset will be transferred to Ermler. Equal payments under the lease are $220,000 (including $20,000 executory costs) and are due on December 31 of each year. The first payment was made on December 31, Collectibility of the remaining lease payments is reasonably assured, and Castro has no material cost uncertainties. The normal sales price of the equipment is $770,000, and cost is $600,000. For the year ended December 31, 2008, what amount of income should Castro realize from the lease transaction? a. $170,000 *93. Carey sold its headquarters building at a gain, and simultaneously leased back the building. The lease was reported as a capital lease. At the time of the sale, the gain should be reported as d. a deferred gain. *94. On December 31, 2008, Devin Corp. sold a machine to Ryan and simultaneously leased it back for one year. Pertinent information at this date follows: Sales price $900,000 Carrying amount 825,000 Present value of reasonable lease rentals ($7,500 for 12 12%) 85,000 Estimated remaining useful life 12 years In Devin s December 31, 2008 balance sheet, the deferred profit from the sale of this machine should be d. $0.

9 Chapter 19 F1. Taxable income is a tax accounting term and is also referred to as income before taxes. F2. Pretax financial income is the amount used to compute income tax payable. T3. Taxable amounts increase taxable income in future years. T4. A deferred tax liability represents the increase in taxes payable in future years as a result of taxable temporary differences existing at the end of the current year. F5. Deductible amounts cause taxable income to be greater than pretax financial income in the future as a result of existing temporary differences. T6. A deferred tax asset represents the increase in taxes refundable in future years as a result of deductible temporary differences existing at the end of the current year. F7. A company reduces a deferred tax asset by a valuation allowance if it is probable that it will not realize some portion of the deferred tax asset. T8. Companies should consider both positive and negative evidence to determine whether it needs to record a valuation allowance to reduce a deferred tax asset. F9. A company should add a decrease in a deferred tax liability to income tax payable in computing income tax expense. T10. Taxable temporary differences will result in taxable amounts in future years when the related assets are recovered. F11. Examples of taxable temporary differences are subscriptions received in advance and advance rental receipts. T12. Permanent differences do not give rise to future taxable or deductible amounts. T13. Companies must consider presently enacted changes in the tax rate that become effective in future years when determining the tax rate to apply to existing temporary differences. F14. When a change in the tax rate is enacted, the effect is reported as an adjustment to income tax payable in the period of the change. F15. Under the loss carryback approach, companies must apply a current year loss to the most recent year first and then to an earlier year. T16. The tax effect of a loss carryforward represents future tax savings and results in the recognition of a deferred tax asset. T17. A possible source of taxable income that may be available to realize a tax benefit for loss carryforwards is future reversals of existing taxable temporary differences. T18. An individual deferred tax asset or liability is classified as current or noncurrent based on the classification of the related asset/liability for financial reporting purposes. F19. Companies should classify the balances in the deferred tax accounts on the balance sheet as noncurrent assets and noncurrent liabilities. F20. The FASB believes that the deferred tax method is the most consistent method for accounting for income taxes. 21. Taxable income of a corporation b. differs from accounting income due to differences in interperiod allocation and permanent differences between the two methods of income determination. 22 Taxable income of a corporation differs from pretax financial income because of Permanent Temporary Differences Differences c. Yes Yes 23. Interperiod income tax allocation causes a. tax expense shown on the income statement to equal the amount of income taxes payable for the current year plus or minus the change in the deferred tax asset or liability balances for the year. 24. The deferred tax expense is the b. increase in balance of deferred tax liability minus the increase in balance of deferred tax asset. 25. The rationale for interperiod income tax allocation is to a. recognize a tax asset or liability for the tax consequences of temporary differences that exist at the balance sheet date. 26. Interperiod tax allocation results in a deferred tax liability from

10 d. the amount of deferred tax consequences attributed to temporary differences that result in net taxable amounts in future years. 27. Which of the following situations would require interperiod income tax allocation procedures? c. A temporary difference exists at the balance sheet date because the tax basis of an asset or liability and its reported amount in the financial statements differ 28. Interperiod income tax allocation procedures are appropriate when d. differences between net income for tax purposes and financial reporting occur because, even though financial accounting principles and tax laws concur on the item to be recognized as revenues and expenses, they don't concur on the timing of the recognition. 29. Interperiod tax allocation would not be required when b. statutory (or percentage) depletion exceeds cost depletion for the period. 30. Machinery was acquired at the beginning of the year. Depreciation recorded during the life of the machinery could result in Future Future Taxable Amounts Deductible Amounts a. Yes Yes P31. A temporary difference arises when a revenue item is reported for tax purposes in a period After it is reported Before it is reported in financial income in financial income a. Yes Yes S32. At the December 31, 2007 balance sheet date, Garth Brooks Corporation reports an accrued receivable for financial reporting purposes but not for tax purposes. When this asset is recovered in 2008, a future taxable amount will occur and b. Garth will record a decrease in a deferred tax liability in P33. Assuming a 40% statutory tax rate applies to all years involved, which of the following situations will give rise to reporting a deferred tax liability on the balance sheet? I. A revenue is deferred for financial reporting purposes but not for tax purposes. II. A revenue is deferred for tax purposes but not for financial reporting purposes. III. An expense is deferred for financial reporting purposes but not for tax purposes. IV. An expense is deferred for tax purposes but not for financial reporting purposes. c. items II and III only S34. A major distinction between temporary and permanent differences is d. temporary differences reverse themselves in subsequent accounting periods, whereas permanent differences do not reverse. S35. Which of the following are temporary differences that are normally classified as expenses or losses that are deductible after they are recognized in financial income? b. Product warranty liabilities. S36. Which of the following is a temporary difference classified as a revenue or gain that is taxable after it is recognized in financial income? c. An installment sale accounted for on the accrual basis for financial reporting purposes and on the installment (cash) basis for tax purposes. S37. Which of the following differences would result in future taxable amounts? d. Expenses or losses that are tax deductible before they are recognized in financial income. 38. Renner Corporation's taxable income differed from its accounting income computed for this past year. An item that would create a permanent difference in accounting and taxable incomes for Renner would be c. a fine resulting from violations of OSHA regulations. 39. An example of a permanent difference is d. all of these. 40. Which of the following will not result in a temporary difference? d. All of these will result in a temporary difference. 41. A company uses the equity method to account for an investment. This would result in what type of difference and in what type of deferred income tax?

11 Type of Difference Deferred Tax d. Temporary Liability 42. A company records an unrealized loss on short-term securities. This would result in what type of difference and in what type of deferred income tax? Type of Difference Deferred Tax b. Temporary Asset S43. When a change in the tax rate is enacted into law, its effect on existing deferred income tax accounts should be c. reported as an adjustment to tax expense in the period of change. 44. Tax rates other than the current tax rate may be used to calculate the deferred income tax amount on the balance sheet if c. the future tax rates have been enacted into law. 45. Recognition of tax benefits in the loss year due to a loss carryforward requires b. the establishment of a deferred tax asset. 46. Major reasons for disclosure of deferred income tax information is (are) d. all of these. 47. Accounting for income taxes can result in the reporting of deferred taxes as any of the following except c. a contra-asset account. 48. Deferred taxes should be presented on the balance sheet b. in two amounts: one for the net current amount and one for the net noncurrent amount. 49. Deferred tax amounts that are related to specific assets or liabilities should be classified as current or noncurrent based on d. the classification of the related asset or liability. 50. Tanner, Inc. incurred a financial and taxable loss for Tanner therefore decided to use the carryback provisions as it had been profitable up to this year. How should the amounts related to the carryback be reported in the 2007 financial statements? d. The refund claimed should be shown as a reduction of the loss in S51. A deferred tax liability is classified on the balance sheet as either a current or a noncurrent liability. The current amount of a deferred tax liability should generally be c. based on the classification of the related asset or liability for financial reporting purposes. 52. All of the following are procedures for the computation of deferred income taxes except to c. measure the total deferred tax asset for deductible temporary differences and operating loss carrybacks. 53. Smiley Corporation purchased a machine on January 2, 2006, for $2,000,000. The machine has an estimated 5-year life with no salvage value. The straight-line method of depreciation is being used for financial statement purposes and the following MACRS amounts will be deducted for tax purposes: 2006 $400, $230, , , , ,000 Assuming an income tax rate of 30% for all years, the net deferred tax liability that should be reflected on Smiley's balance sheet at December 31, 2007, should be Deferred Tax Liability Current Noncurrent a. $0 $72,000 Use the following information for questions 54 through 56. Hefner Co. at the end of 2007, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $ 500,000 Estimated litigation expense 1,250,000 Installment sales (1,000,000) Taxable income $ 750,000 The estimated litigation expense of $1,250,000 will be deductible in 2009 when it is expected to be paid. The gross profit from the installment sales will be realized in the amount of $500,000 in

12 each of the next two years. The estimated liability for litigation is classified as noncurrent and the installment accounts receivable are classified as $500,000 current and $500,000 noncurrent. The income tax rate is 30% for all years. 54. The income tax expense is a. $150, The deferred tax asset to be recognized is d. $375,000 noncurrent. 56. The deferred tax liability current to be recognized is c. $150,000. Use the following information for questions 57 through 59. Frizell Co. at the end of 2007, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $ 750,000 Estimated litigation expense 1,000,000 Extra depreciation for taxes (1,500,000) Taxable income $ 250,000 The estimated litigation expense of $1,000,000 will be deductible in 2008 when it is expected to be paid. Use of the depreciable assets will result in taxable amounts of $500,000 in each of the next three years. The income tax rate is 30% for all years. 57. Income tax payable is b. $75, The deferred tax asset to be recognized is d. $300,000 current. 59. The deferred tax liability to be recognized is Current Noncurrent c. $0 $450, Markes Corporation's partial income statement after its first year of operations is as follows: Income before income taxes $3,750,000 Income tax expense Current $1,035,000 Deferred 90,000 1,125,000 Net income $2,625,000 Markes uses the straight-line method of depreciation for financial reporting purposes and accelerated depreciation for tax purposes. The amount charged to depreciation expense on its books this year was $1,500,000. No other differences existed between book income and taxable income except for the amount of depreciation. Assuming a 30% tax rate, what amount was deducted for depreciation on the corporation's tax return for the current year? d. $1,800, Dwyer Company reported the following results for the year ended December 31, 2007, its first year of operations: 2007 Income (per books before income taxes) $ 750,000 Taxable income 1,200,000 The disparity between book income and taxable income is attributable to a temporary difference which will reverse in What should Dwyer record as a net deferred tax asset or liability for the year ended December 31, 2007, assuming that the enacted tax rates in effect are 40% in 2007 and 35% in 2008? b. $157,500 deferred tax asset 62. In 2007, Admire Company accrued, for financial statement reporting, estimated losses on disposal of unused plant facilities of $1,500,000. The facilities were sold in March 2008 and a $1,500,000 loss was recognized for tax purposes. Also in 2007, Admire paid $100,000 in premiums for a two-year life insurance policy in which the company was the beneficiary. Assuming that the enacted tax rate is 30% in both 2007 and 2008, and that Admire paid $780,000 in income taxes in 2007, the amount reported as net deferred income taxes on Admire's balance sheet at December 31, 2007, should be a

13 d. $450,000 asset. Use the following information for questions 63 and 64. O Malley Corporation prepared the following reconciliation for its first year of operations: Pretax financial income for 2008 $ 900,000 Tax exempt interest (75,000) Originating temporary difference (225,000) Taxable income $600,000 The temporary difference will reverse evenly over the next two years at an enacted tax rate of 40%. The enacted tax rate for 2008 is 35%. 63. What amount should be reported in its 2008 income statement as the deferred portion of the provision for income taxes? a. $90,000 debit 64. In O Malley s 2008 income statement, what amount should be reported for total income tax expense? c. $300, Jesse Company sells household furniture. Customers who purchase furniture on the installment basis make payments in equal monthly installments over a two-year period, with no down payment required. Jesse's gross profit on installment sales equals 40% of the selling price of the furniture. For financial accounting purposes, sales revenue is recognized at the time the sale is made. For income tax purposes, however, the installment method is used. There are no other book and income tax accounting differences, and Jesse's income tax rate is 30%. If Jesse's December 31, 2007, balance sheet includes a deferred tax liability of $300,000 arising from the difference between book and tax treatment of the installment sales, it should also include installment accounts receivable of a. $2,500, Cromwell Company has the following cumulative taxable temporary differences: 12/31/08 12/31/07 $1,350,000 $960,000 The tax rate enacted for 2008 is 40%, while the tax rate enacted for future years is 30%. Taxable income for 2008 is $2,400,000 and there are no permanent differences. Cromwell's pretax financial income for 2008 is b. $2,790,000. Use the following information for questions 67 through 69. McGee Company deducts insurance expense of $84,000 for tax purposes in 2008, but the expense is not yet recognized for accounting purposes. In 2009, 2010, and 2011, no insurance expense will be deducted for tax purposes, but $28,000 of insurance expense will be reported for accounting purposes in each of these years. McGee Company has a tax rate of 40% and income taxes payable of $72,000 at the end of There were no deferred taxes at the beginning of What is the amount of the deferred tax liability at the end of 2008? a. $33, What is the amount of income tax expense for 2008? a. $105, Assuming that income tax payable for 2009 is $96,000, the income tax expense for 2009 would be what amount? d. $84,800 Tyler Company made the following journal entry in late 2008 for rent on property it leases to Danford Corporation. Cash 60,000 Unearned Rent 60,000 The payment represents rent for the years 2009 and 2010, the period covered by the lease. Tyler Company is a cash basis taxpayer. Tyler has income tax payable of $92,000 at the end of 2008, and its tax rate is 35%. 70. What amount of income tax expense should Tyler Company report at the end of 2008? b. $71,000

14 71. Assuming the taxes payable at the end of 2009 is $102,000, what amount of income tax expense would Tyler Company record for 2009? c. $112, The following information is available for Nielsen Company after its first year of operations: Income before taxes $250,000 Federal income tax payable $104,000 Deferred income tax (4,000) Income tax expense 100,000 Net income $150,000 Nielsen estimates its annual warranty expense as a percentage of sales. The amount charged to warranty expense on its books was $95,000. Assuming a 40% income tax rate, what amount was actually paid this year for warranty claims? d. $85,000 Accounting for Income Taxes Meyers Co. had a deferred tax liability balance due to a temporary difference at the beginning of 2007 related to $600,000 of excess depreciation. In December of 2007, a new income tax act is signed into law that lowers the corporate rate from 40% to 35%, effective January 1, If taxable amounts related to the temporary difference are scheduled to be reversed by $300,000 for both 2008 and 2009, Meyers should increase or decrease deferred tax liability by what amount? b. Decrease by $15, A reconciliation of Reaker Company's pretax accounting income with its taxable income for 2008, its first year of operations, is as follows: Pretax accounting income $3,000,000 Excess tax depreciation (90,000) Taxable income $2,910,000 The excess tax depreciation will result in equal net taxable amounts in each of the next three years. Enacted tax rates are 40% in 2008, 35% in 2009 and 2010, and 30% in The total deferred tax liability to be reported on Reaker's balance sheet at December 31, 2008, is b. $30, Mast, Inc. reports a taxable and financial loss of $650,000 for Its pretax financial income for the last two years was as follows: 2006 $300, ,000 The amount that Mast, Inc. reports as a net loss for financial reporting purposes in 2008, assuming that it uses the carryback provisions, and that the tax rate is 30% for all periods affected, is d. $455,000 loss. Use the following information for questions 76 and 77. Neasha Corporation reported the following results for its first three years of operation: 2006 income (before income taxes) $ 100, loss (before income taxes) (900,000) 2008 income (before income taxes) 1,000,000 There were no permanent or temporary differences during these three years. Assume a corporate tax rate of 30% for 2006 and 2007, and 40% for Assuming that Neasha elects to use the carryback provision, what income (loss) is reported in 2007? (Assume that any deferred tax asset recognized is more likely than not to be realized.) d. $(550,000) 77. Assuming that Neasha elects to use the carryforward provision and not the carryback provision, what income (loss) is reported in 2007? b. $(540,000) 78. Peck Co. reports a taxable and pretax financial loss of $400,000 for Peck's taxable and pretax financial income and tax rates for the last two years were:

15 2006 $400,000 30% ,000 35% The amount that Peck should report as an income tax refund receivable in 2008, assuming that it uses the carryback provisions and that the tax rate is 40% in 2008, is a. $120, Bennington Corporation began operations in There have been no permanent or temporary differences to account for since the inception of the business. The following data are available: Year Enacted Tax Rate 45% 40% 35% 30% Taxable Income $750, ,000 In 2008, Bennington had an operating loss of $930,000. What amount of income tax benefits should be reported on the 2008 income statement due to this loss? a. $409, Ramos Corp.'s books showed pretax financial income of $1,500,000 for the year ended December 31, In the computation of federal income taxes, the following data were considered: Gain on an involuntary conversion $650,000 (Ramos has elected to replace the property within the statutory period using total proceeds.) Depreciation deducted for tax purposes in excess of depreciation deducted for book purposes 100,000 Federal estimated tax payments, ,000 Enacted federal tax rate, % What amount should Ramos report as its current federal income tax liability on its December 31, 2008 balance sheet? a. $100, Eddy Corp.'s 2008 income statement showed pretax accounting income of $750,000. To compute the federal income tax liability, the following 2008 data are provided: Income from exempt municipal bonds $ 30,000 Depreciation deducted for tax purposes in excess of depreciation deducted for financial statement purposes 60,000 Estimated federal income tax payments made 150,000 Enacted corporate income tax rate 30% What amount of current federal income tax liability should be included in Eddy's December 31, 2008 balance sheet? a. $48, On January 1, 2007, Lebo, Inc. purchased a machine for $720,000 which will be depreciated $72,000 per year for financial statement reporting purposes. For income tax reporting, Lebo elected to expense $80,000 and to use straight-line depreciation which will allow a cost recovery deduction of $64,000 for Assume a present and future enacted income tax rate of 30%. What amount should be added to Lebo's deferred income tax liability for this temporary difference at December 31, 2007? c. $21, On January 1, 2007, Magee Corp. purchased 40% of the voting common stock of Reed, Inc. and appropriately accounts for its investment by the equity method. During 2007, Reed reported earnings of $360,000 and paid dividends of $120,000. Magee assumes that all of Reed's undistributed earnings will be distributed as dividends in future periods when the enacted tax rate will be 30%. Ignore the dividend-received deduction. Magee's current enacted income tax rate is 25%. The increase in Magee's deferred income tax liability for this temporary difference is d. $28, Brock Corp.'s 2007 income statement had pretax financial income of $250,000 in its first year of operations. Brock uses an accelerated cost recovery method on its tax return and Taxes Paid $337, ,000