Taxes and Leases

Intraperiod Tax Allocation

matches tax provision to components of net income and retained earnings

Interperiod Tax Allocation

Results from differences between the IRS Tax code-based return and GAAP based financial statements

Current Year taxes

payable (liability) or refundable (assets)

Future year Taxes

Deferred tax asset or liability

Total tax expense (benefit)

Total of current tax expense (benefit) and deferred tax expense (benefit)

Current Income tax expense (benefit)

Amount payable (refundable) based on the current year per the corporate income tax return (Form 1120)

Deferred income tax expense (benefit)

Change in deferred tax liability or deferred tax asset during the period (balance sheet approach)

Permanent Differences of Interperiod Tax

• Affects either book income or taxable income, but not both

• Does not reverse, no deferred tax, no interperiod tax allocation

• Examples:

  • Tax exempt interest (municipal, state)

  • Life insurance proceeds on officer’s key man policy

  • Life insurance premiums when corporation is beneficiary

  • Certain penalties, fines, bribes, kickbacks, etc

  • Nondeductible portion of meal and entertainment expense

  • Dividends-received deduction for corporations

  • Excess percentage depletion over cost depletion

Deferred Tax Liability

Future taxable income will be greater than future financial accounting income

Deferred Tax Asset

Anticipated that future taxable income will be less than future financial accounting income. If more likely than not that some or all of the asset will not be realized, a valuation allowance must be recognized against the asset value.

Lessor

Conveys the right to control the use of real/personal property

Lessee

Agrees to pay consideration for this right over a period of time.

• Contract must depends on an identifiable asset where lessor does not have a substantive right to substitution.

• Right to control the asset must be conveyed to the lessee.

OWNES Criteria

• Ownership transfers to the lessee at the end of the lease term

• Written purchase option which lessee is reasonably certain to exercise

• Net Present Value equal to or substantially exceed fair value of asset

• Economic Life (major part) of the underlying asset within lease term

• Specialized asset such that it will not have an expected, alternative use to lessor.

Ownership

transfers to the lessee at the end of the lease term

Written

purchase option which lessee is reasonably certain to exercise

Net present value

equal to or substantially exceeds fair value of asset

Economic life

(major part) of the underlying asset within lease term

Specialized

asset such that it will not have an expected alternative use to lessor

Lessee Accounting for Operating Leases BS

Balance Sheet

• Right- of- use (ROU) ASSET AND LEASE LIABILITY

• Amortized using the effective interest method over the life of the lease

• Value based on present value of lease payments at an appropriate discount rate

Lessee Accounting for Operating Leases IS

Income Statement

• Lease Expense (inclusive of interest expense)

ROU Asset and Liability Calculations

Inputs into the calculation of the ROU asset and lease liability must be properly evaluated and calculated

• Lease Terms

• Lease payment

• Discount rate

Lease term

noncancellable period for which a lessee has the right to use the underlying asset

• In determining the lease term, extension option that are reasonably certain to be exercised should be included as well as periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option.

Lease payments

Fixed payments, variable payments based on an index or rate, exercise price or penalties associated with options that are reasonably certain to be exercised, or any amounts probable under a residual value guarantee.

Discount rate

Rate implicit in the lease: if that rate is not readily determinable, the lessee must use its incremental borrowing rate.

Lessee Accounting For Finance Leases BS

Balance Sheet

• ROU asset and lease liability

• Asset includes the amount of the lease liability plus initial direct costs connected to lease execution, any lease payments made by lessee, and lease incentives received

• Liability represents the present value of lease payments owed over the lease term

Lessee Accounting for Finance Leases IS

Income Statement

• Interest expense recognized based on amortization of lease liability (you do separate the interest expense from the lease expense)

• ROU asset amortized on a straight-line basis, unless another basis is more representative of the pattern in which the lessee expects to consume the future economic benefits of the asset.

Gain or loss on sale of land.

Using the approach known as intraperiod tax allocation, income tax expense(or benefit) should be allocated to all of the following except