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Hendrick leases; deferred tax, temporary & permanent differences, accounting changes

On January 1, 2000, Hendrick Company entered into two non-cancelable leases for machines to be used in its manufacturing operations. The first lease transfers ownership of the machine to the lessee by the end of the lease term. The second lease contains a bargain purchase option. Payments have been made on both leases during 2000.

Required:
1. How should Hendrick classify each of the two leases? Why?
2. How should a lessee report a Capital lease on it's balance sheet and income statement?
3. How should a lessee report an operating lease on it's balance sheet and income statement?

One of the longest debates in accounting history is the issuance of deferred taxes. The controversy began in the 1940's and has continued, even after the FASB issued Statement of Financial Accounting Standards No. 109 in 1992. At issue id the appropriate treatment of tax consequences of economic events that occur in years other than that of the events themselves.

Required:
1. Distinguish between temporary differences and permanent differences. Provide an example of each.
2. Distinguish between intraperiod tax allocation and interperiod tax allocation (deferred tax accounting). Provide an example of each.
3. How are deferred tax assets and deferred tax liabilities classified and reported in the financial statements?

Indicate with the appropriate letter the nature of each situation described below:

Type of Change:

PC Change in Principle reported currently
PR Change in Principle reported retroactively
PP Change in principle reported prospectively
E Change in Estimate
R Change in Reporting Entity
N Not an Accounting Change

____ Change in Declining Balance Depreciation to straight line
____ Change in the estimated useful life of office equipment
____ Technological advance that renders worthless a patent with an unamortized cost of $45,000.
____ Change from determining lower of cost to market for the inventories by the individual item approach to the aggregate approach.
____ Change from LIFO inventory costing to the weighted average inventory costing.
____ Settling a lawsuit for less than the amount accrued previously as a loss contingency.
____ Including in the consolidated financial statements a subsidiary acquired several years earlier that was appropriately not included in previous years
____ Change by a retail store from reporting bad debt expense on a pay-as-you-go basis to the allowance method
____ A shift of certain manufacturing overhead costs to inventory that previously were expensed as incurred to more accurately measure costs of goods sold (Either method is generally acceptable).
____ Pension plan assets for a defined benefit pension plan achieving a rate of return in excess of the amount anticipated

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1. both leases are Capital leases. Because the conditions for Capital lease classification are:
a) transferring ownership of the asset to the lessee by the end of the lease term
b) a bargain purchase option exists
c) the lease period is at least 75% of the asset's life
d) the PV of the lease payment is at least 90% of the fair value of the asset therefore, the two machines matches conditions a and b respectively.

2. for the lessee to report a Capital lease:
- at the inception of the lease, the leased "asset and liability" is recognized on the balance sheet by an amount equal to the present value of the minimum lease payments.
- During the life of the lease, the leased asset is depreciated on the income statement and the lease payment is separated into interest expense and principal payments.

3. for the lessee to report an operating lease:
- at the inception of the lease, no entries are made in the statements
- During the life of the lease, rent expense equal to the lease payments is charged to income. Footnote disclosure of the lease payment for each on the next 5 years is required.

Required:
1. Distinguish between temporary differences and permanent differences. Provide an example of each.
2. Distinguish between intraperiod tax allocation and interperiod tax allocation (deferred tax accounting). Provide an example of each. ...

Solution Summary

The solution provides a detailed narrative to explain all the problems in this set.

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