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I want to cover some of the more difficult topics first If dont get to all the slidesthe entire lecture will be posted to the course web site
EQUIPMENT
What depreciation methods does the Company use for these assets? What estimated useful lives have been used for these assets in the past? Are depreciation methods the same for book and tax?
For book purposes, a straight-line basis over 5 years for equipment and over 6 years for crew trucks is used. For tax purposes, the client records depreciation using MACRS for the trucks. The Net Book Value of the trucks exceeds the tax basis at the end of Year 20X3--resulting in a Deferred Tax Liability (long-term) that will soon start reversing!
LEASED ASSETS
Why has the lease been recorded (capitalized) as an asset of $380,000 and a liability of $380,000?
GAAP Rule = The lease has been recorded as an asset because SFAS No. 13 requires that leases with terms that exceed 75% of the estimated economic life receive such treatment. (Lease life and building life are both 20 years) Conceptually = this is like an installment loan to purchase the assets with rewards and risks of ownership passing to Hydromaintthe leasee
Is the asset being depreciated (amortized)? If so, how and over what period of time? Is the depreciation the same for book and tax? How are deferred taxes impacted?
Yes, the capital lease asset is depreciated on a straight line basis at $19,000 per year over the 20 years. For tax purposes the leases are operating, so no depreciation is allowed. Deferred tax ASSET (long-term) created by the temporary difference related to the lease: the net book value of the capitalized lease (net book value of lease asset less both principal balance on lease obligation and less Accrued Interest Payable) is less than the tax basis (Prepaid Rent) of the lease at the end of 20X3 OR Depreciation Expense + Interest Expense deductions on Books is GREATER than Rent Expense on Tax Return in Early years of Leasethus the Government Owes Hydromaint some future tax deductions. This is similar to Bad Debt Expense
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LEASED ASSETS
Is this the Projected Benefit Obligation (PBO)? NO, the PBO (and the plan assets) only appears in the note disclosure
How is this Accrued Pension Liability calculated? Normally = Cumulative Pension Expense that has been recorded over the years vs. Cumulative Employer Cash Contributions to Plan Trustee
However in Year 3 needed to Increase the recorded Accrued Pension Liability amount to get the liability up to the Minimum Pension Liability (excess of ABO over plan assets). ABO (Accumulated Benefit Obligation using existing salary rates is only used to compute the Minimum Pension Liability
How does the client get the amount to record this asset?
This amount is the difference between the Accrued Pension Liability that exists from the regular pension entry and the minimum pension liability that must be reported (excess of ABO vs. Fair market value of pension fund assets)
DEFERRED TAXES
How is the Deferred Tax Liability or Asset journal entry for the year calculated?
This amount represents the change in the difference between book and tax basis between years multiplied by the tax rate. OR Temporary differences between current years tax return revenue and expenses VS. current years Income Statement revenue and expenses multiplied by the tax rate
Has the client had any problems recording this liability in the past?
Yes, the client has had problems with tax entries in every year of the engagement.
DEFERRED TAXES
What permanent and temporary differences has Hydromaint encountered in the past?
Temporary differences: accounts receivable (why?) truck depreciation (why?) Building lease (why?) trading securities (why?) Permanent differences: dividends received deduction (why?)
8000
Equity Securities Allowance (114) Market (Loss) Recovery Short-Term(801) To mark to market the trading securities
13000 13000
Depreciation expense - trucks (701) 6000 Accumulated depreciation (182) 6000 To record depreciation expense related to capitalized R&M incurred on 1/1/x3.
Leased assets (191) Capital leases - liability (415) To record a capital lease 380000 380000
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Amortization of capital leases (712) Accumulated depreciation (192) To record depreciation on the capital lease.
19000 19000
Capital lease liability (415) 6,503 Short-term debt (321) To reclassify the current lease payable.
6,503
Interest Expense - Lease (755) 20,123 Interest Payable (311) To accrue interest expense on the lease liability.
20,123
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5,950
110,000 110,000
127,575
127,575
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80,499
80,499
Increase Accrued Pension Liability up to need Minimum Required Liability balance of $98,074.
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Income Tax Expense (821) 26,646 Current Taxes Payable (312) 12,983 Deferred Income Taxes L-T (421) 12,103 Deferred Income Taxes S-T (141) 1,560 (See Year Threes Work Papers OR Correcting Journal Entries for Year 3 for supporting detail of Tax Entries)
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REVIEW OF YEAR 3
General Questions about our engagement and the client Review of Balance Sheet Review of Correcting Entries
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Who is the partner on the Hydromaint engagement? How did he get this client?
Tom Lockhart (play tennis & racquetball with Nick Riley, and estate work)
Who is the tax person from our firm who is assigned to Hydromaint?
Linda Dirkee
What level of service are we providing for Hydromaint? Why does client require it?
REVIEW through Year 3 (Starting in Year 4 it will be an AUDIT; Why?) Bank Loan Agreement (to get financing for trucks) requires it Bank Loan Officer that Hydromaint deals with = Roger Sontag
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What are analytical procedures? What is an example of an analytical procedure for Hydromaint?
Analytical Procedures = ratio and trend analysis Compare over time the percentage of Allowance to Total A. R.
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How would you determine the amount we charged Hydromaint for last years Review?
Look in general ledger account #609 SELLING & ADMIN PROFESSIONAL FEES and find our invoice
Why else might we look at every invoice (even if not material in amount in that particular account)?
Find invoices from attorneys the client engaged. We want to be aware of them and what cases they were working on.
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ACCOUNTS RECEIVABLE
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ACCOUNTS RECEIVABLE
What is the correct method of valuing Accounts Receivable (i.e., what should the Balance Sheet show for Accounts Receivable)?
Net Realizable Value (NRV)
Therefore, which related account have we been dealing with because of the VALUATION issue for Hydromaints Accounts Receivable?
Adequacy of the allowance for uncollectible accounts
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INVENTORY
Has the client previously had any problems accounting for this asset in the past?
Yes, in Year 1 the client did not inventory these at year-end and expensed all items purchased.
SUPPLIES
What cost flow assumptions does the client use with respect to this asset?
FIRST IN, FIRST OUT (FIFO)
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TRADING SECURITIES
What are the similarities and differences between the accounting for the Trading Securities vs. the Available for Sale Securities?
Both have asset value marked to market Trading Securities = unrealized gain/loss through Income Statement Available for Sale Securities: Unrealized gain/loss NOT included on Income Statement Unrealized gain/loss directly to Stockholders Equity on Balance Sheet (and also considered part of Comprehensive Income)
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EQUIPMENT
What problem has the client had in the past with recording the proper amounts in this asset category?
Hydromaint has previously incorrectly expensed as Repair and Maintenance Expense costs of $30,000 that should have been capitalized as an asset. World Com did just the opposite Auditors frequently test large amounts in both Asset & R&M Expense accounts looking for improper capitalization of costs
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LICENSING COSTS
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ACCOUNTS PAYABLE
What types of liabilities does the client include in this liability class?
Principally, payables incurred for the acquisition of maintenance supplies inventory. Remember for the Direct Method of Calculating Cash from Operations: The Cash Paid to Vendors = Cost of Services Expense +/- Change in Inventory +/- Change in Accounts Payable
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What does this $6,041 liability actually represent? Is it the total tax liability due this year?
It is the current tax liability due and unpaid in the current year. It is the beginning balance of $1,210 plus the $12,983 increase for the year (per our tax entry) minus the $8,152 cash payment made during the year.
Has the firm had any problems properly recording the income tax payable in the past?
Yes. The client has needed assistance every year in recording tax expense and the related assets and liabilities correctly.
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INTEREST PAYABLE
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NOTE PAYABLE
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OTHER QUESTIONS
What were the major accounting issues confronted by you during Hydromaints first three years?
Accounting for Contingencies (Bad Debts) Trading securities Accounting for investments Lease Capitalization Interest capitalization Temporary differences for PP&E and lease capitalization Bank debt and related covenants Pensions Contract revenue recognition (ALL OF THESE TOPICS YOU LEARNED BY ENCOUNTERING THEM IN A REAL-WORLD CONTEXTNOT THE TRADITIONAL LECTURE. THE LEARNING PROCESS SHOULD SERVE YOU WELL IN THE FUTURE!)
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