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    Methodology for deferred taxes, accounting changes, errors

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    As the CPA for a large organization, your manager has asked you to provide information to outside CPAs who are examining a subsidiary that has been set up as a corporation. As part of their review, the CPAs have asked you to provide them with the following explanations:

    - The methodology used to determine deferred taxes
    - The procedures for reporting accounting changes and error corrections
    - The rationale behind establishing the subsidiary as a corporation
    - Prepare your response to the three questions. Provide draft responses to the above questions.
    - Before submitting your response, your manager would like to know a little bit more about the request. She has asked you to tell her what your professional responsibilities are as a CPA, and the difference between a review and an audit. Additionally, provide your manager with a summary of your responsibilities in an internal memo (no more than 1,050 words)

    Formatting and General Comments: One document is preferred (it makes it easier to grade and return to the student). You may answer the first three questions in word, before or after the memo. The formatting specifics are not as important as the content. Be sure to answer all questions completely. As always, when citing outside sources APA formatting is required.

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    Solution Preview

    The methodology used to determine deferred taxes

    We determine deferred taxes by computing taxable income (based on tax return) and entering that as taxes payable. Then, we examine the differences between accrual GAAP income and taxable income. If the differences will turn around in future years, they are timing differences and the difference is booked to deferred tax liability (or deferred tax asset). If the difference is a permanent difference (never going to be reported in both earnings and tax return), the tax expense is adjusted for the permanent difference.

    If we have a deferred tax liability or deferred tax asset, we use the rate that we believe will be in effect when the items turns around (not in the year it originates). Sometimes rates change between the years an item originates and when it turns around and so the deferred tax liability or asset is adjusted (to tax expense) for these rate changes.

    The procedures for reporting accounting changes and error corrections

    If there are errors, we see if the magnitude of the error is material. If it is, we treat it as a prior period adjustment and book the correcting entry to beginning retained earnings. If the error is small, we record the correcting entry in the current period.

    Changes in estimates are handled prospectively (fix current year and future year for new assumptions).

    Changes in accounting method or policy that is ...

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