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10-1 Odd-numbered Solutions CHAPTER 10 LIABILITIES: OFF-BALANCE-SHEET FINANCING, LEASES, DEFERRED INCOME TAXES, AND RETIREMENT BENEFITS Questions, Short Exercises, Exercises, Problems, and Cases: Answers and Solutions 10.1 See the text or the glossary at the end of the book. 10.3 Using an executory contract to achieve off-balance-sheet financing results in the recognition of neither an asset (for example, leased assets) nor a liability (for example, lease liability) on the balance sheet. Using an asset sale with recourse results in a decrease in an asset (for example, accounts receivable) and an increase in cash. In both cases, no liability appears on the balance sheet. 10.5 The distinction depends upon which criteria of the lease made it a capital lease. The major difference is that at the end of a lease term the asset reverts to the lessor in a capital lease, whereas at the end of the installment payments, the asset belongs to the purchaser. The criteria for capitalizing a lease are such that the expected value of the asset when it reverts to the lessor is small, but misestimates can occur. In most other respects, capital leases and installment purchases are similar in economic substance. 10.7 Expenses are gone assets. The measure of expense over the life of a lease is the total outflow of cash to discharge the obligation. The accounting for leases, either operating or capital, does not change the total cash outflow, only the timing of the recognition of asset expirations. 10.9 Deferred tax accounting matches against pre-tax book income each period the income taxes a firm has to pay currently plus (minus) the income taxes the firm expects to pay (save) in the future when revenues and expenses that appear in book income now appear in tax returns later. 10.11 The Congress defines the manner in which firms calculate taxable income and income taxes payable. Corporations pay the income taxes each year that the income tax law legally requires them to pay. The amount shown for Deferred Tax Liability is not a liability. It may become a liability if the firm earns taxable income in the future. It represents the cumulative tax savings from using different methods of accounting for financial reporting and income tax purposes. The Congress and the FASB permit such differences in accounting methods because the objectives of income taxation
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Odd-numbered Solutions 10-2 10.11 continued. and financial reporting differ. The income taxation system attempts to raise revenues in an equitable manner. Generally accepted accounting principles attempt to measure operating performance and financial position. If the Congress feels that it should not permit such differences, it should legislate either (1) that firms prepare their financial statements in conformance with the accounting methods used for tax purposes, or (2) that they compute taxable income in accordance with the accounting methods used for financial reporting purposes. Both approaches result in eliminating the Deferred Tax Liability account. Given the differences in objectives of the two reporting
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