When you arrive at C&M for the afternoon, Conner and Martin are arguing with Lop

Question

When you arrive at C&M for the afternoon, Conner and Martin are arguing with Lopez and Knepp about, of all things, the corporate income taxes. As you walk in, you hear Conner saying, "The corporate rate is always 35%." For some reason, Knepp is talking about something called SFAS No. 109 that has to do with how taxes are reported in financial statements (deferred taxes). This discussion is not clear to you since you have not yet had a tax course, so you figure you will learn a lot this afternoon. (You had no idea at this point how much you would learn.) Instructions Access the attached Excel ™ to perform the following analysis. This file contains the balance sheet and income statement reflecting forecasts for 2016. Review the income statement and verify that the tax is indeed 35% of income before tax for both 2015 and 2016. (a) Since Knepp has raised the issue of SFAS No. 109, access the FASB Codification and read the information describing the framework now used in accounting for income taxes. Write a memo that you can take to Conner and Martin describing the change in focus from the income statement to the balance sheet. Describe the concepts of permanent and temporary differences. Give two examples of each and how they reflect the new focus. (b) During the meeting in the afternoon, you ask Knepp and Lopez if there were permanent or temporary differences in 2015 and whether they will continue into 2016. They responded that they were not aware of any differences for either 2015 or 2016. However, in 2016 Conner and Martin were given life insurance policies. The insurance premium on these policies amounted to $80,000 per year. C&M also anticipates investing in local county bonds which should earn about $7,000 investment income in 2016. 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 C&M 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 2016 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. The forecasted income statement reports a tax expense of $178,500. Prepare a memo to Conner and Martin in which you explain the adjusting entry to reflect the income tax expense that should be reported. Additional Activities: Extend your accounting knowledge Since the discussion about tax expense you had yesterday, Conner and Martin have read about something called "deferred taxes." They ask you just what is involved in the concept of deferred taxes. (a) Prepare a memo for Conner and Martin describing when deferred tax assets are recorded and what provisions, if any, have to be accounted for if Conner and Martin believe that the future benefits from the deferred tax asset probably will not be realized. Use the FASB Codification to provide support for your response from the authoritative literature. (b) Write a memo to Conner and Martin describing the potential for earnings management that exists when recording valuation allowances for deferred tax assets. (c) From what you have read about taxes, you realize that there is substantial judgment in the determination of tax expense for book purposes. Check the FASB Codification for the guidance on taxes; in particular, check for footnote disclosures required.

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