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Aqua Sante Solutions

Aqua Sante Solutions - Chartered Accountants pp g of...

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Unformatted text preview: Chartered Accountants pp _ g of Ontario Handout Page i of 14 AQUA SANTE 1m: Objectives The objectives of this case are: I To review the accounting for future income taxes and compare to the taxes payahie method option available under differential reporting; I To highlight some of the issues facing small businesses, such as: I Cost vs. benefits of implementing new reporting requirements; and a How reporting requirements may or may not impact decision making of management. I To highlight some of the reporting options available under differential reporting and the impact of those options on the financial statements; and e To introduce the new independence standards. and discuss how they impact the services the smaller accounting firms offer to owner manager type clients. Co mpgeneies This case provides an opportunity to demonstrate numerous pervasive and specific competencies including the following: 1' Pervasive Qualifies and Skills The student anaiyzes information and provides conclusions. II Analyzes Performance Measurement Needs The student evaluates the pros and cons of implementing the new tax section compared to using differential reporting. in Conducts External Financial and Non-Financial Reporting The student provides advice on accounting policies considering the use of differential reporting vs. the new tax section. affirms W 3 Copyright 200‘ lCAD Ediool officccruntaney PFeB Handmtt Page2 of I4 AQUA same we THIS IS NOT A SAMPLE RESPDNSE A. Calculation of Future Income Taxes Asset {Liability} Before one can restate the financial statements to show the impact of implementing future income taxes, it is necessary to calculate what the future income tax asset (liability) should be. The following fi'ameworlt should be followed: 1. Determine the carrying value of each asset and liability and compare it to the tax basis of each asset and liability to determine the extent of any Emporary differences. 2. Determine the appropriate rate to use (Note: not all items are necessarily subject to the same rate. particularly if there is a different tax basis for federal pusposes, in comparison to provincial purposes}. 3. Calculate the FITA (L). If a PITA, determine to what extent it is "more likely than not“ {MLTN} that an unrecognized fiiture income tax asset will be realized. Only if the ML'I‘N test is test should a limits income tax asset be recognized. fiefeiiowing is a flammrkfer determining the extent efi‘entpermy difl'erenees: Carrying Value Tax Basis Assets a] Asset deductible over one or more years Carrying amount less amount deducted to date a Par.12 (a) i.e. Capital asset at NBV i.e. UCC b] Asset deductible when realized Carrying amount - Par. 12 [b] i.e. Portfolio investment at ACE i.e. ACE c] Asset where no tax consequences {not deductible Carrying amount and proceeds not taxable} — Par. 12 {c} i.e. Intangible amortized for accounting, not i.e. No deduction for tax deductible for tax = NEV d} Deductible depending whether utilized or sold Amount related to an asset that will be .— Par. 12ml deductible depending on whether the asset is utilized or sold; tax basis is greater of those two amounts e] Accounting value is nil. Future tax benefits of unused tax losses or unused income tax reduction. i.e., Value of tax loss or unused income tax reduction '3 Como-ight 200d- [CAO School of Accountancy PP-B Handout Page 3 of 14 Carrying Value Tax Basis Liabilities a} Liability Can'ying amount less 5 deducted in future periods -- Par. l3{a} i.e. Accrued expense = $l,flfllfl Le. Carrying value $1,0tl-t] - $l,tlt}t} expensed when paid = nil tax basis 1'!) Liability such as revenue received in advance Carrying amount less amount net taxable in fiiture .- Par. lifb} period is Interest revenue of $1,0flt} deferred for Le. Carrying amount $1 ,tltlll but taxed on a cash accounting basis, so $ 1 ,tlfltl net taxable in future. Tax basis = all e} Liability settled with no tax consequences Carrying amount - Par. Ute] i.e. Loan payable of $1,913) i.e. Repayment has no tax consequences Tax basis = $l,t}flfl Income tax losses and Income tax reductions Amount of tax losses recognized should be lindmd to the amount that is “more likely than not"r to be realized. The following sources of taxable income may be available under the tax law to realize a tax benefit for deductible tenmorary differences, unused tax losses or income tax reductions: {a} Future reversals of existing taxable temporary differences; (b) Future taxable income before the effects of reversing temporary differences, unused tax losses and income tax reductions; (c) Taxable income in prior yeaiis}, it" carry back is permitted under the tax law; and (d) Tax plain-ring strategies that would, if necessary, would be implemented to realize a future income tax asset. Tax planning strategy must be: prudent and feasible, an action that an enterprise ordinarily might not take, but would take to prevent a tax loss or income tax reduction from expiry unused; and would result in realization of future income tax assets. Intangible Asset par. 14“) Under the current Canadian Income Tax Act, “eligible capital expenditures” are deductible for tax purposes to the extent of T594 of the cost incurred, and proceeds are ultimately taxable only to the extent of 3% offl'te ametn‘it received. The tax basis would be the balance in the cumulative eligible capital pool plus 25% of the carrying amount. a Canaan soot iexo School of am PP - [t Handout Page 4 of 14 Capital Lease {for accounting purposes}, operating lease for tax purposes A capital lease obligation is a liability for accounting purposes. The related expenses [i.e.,interest} will be deducted for accounting purposes when paid. However, since the capital lease is treated as an operating lease for tax purposes, interest and principal payments are deductible in the year they are made. Therefore the tax basis of the capital lease is the carrying amount of the debt less any amount that will be deductible for income tax purposes in respect of that liability in future periods. Therefore the tax basis equals $nil. Equipment purchased under capital lease are assets for accounting purposes, but have no tax basis for tax purposes as they have no related UCC. For tax purposes, the amortization is added back. No capital cost allowance is claimed. The difference in treatment between tax and accounting creates a temporary difference. The tax basis of the asset is its UCC, which is nil. The carrying value is the net book value. Determine the appropriate rate Handbook 8.3465 requires the use of “substantially enacted" rates that wiIl be applicable in the future when the current federal rate of income tax on active business income eligible for the small business deduction is 13.12%. If the corporation is not eligible for the small business deduction, then the rate is 29.12% federally. Ontario provincial rates are currently 6.5% on active business income eligible for the small business deduction, and 12.5% for those who are not. Given that the current level of income is in excess of $59fl,flflfl before taxes. it may be argued that the higher tax rates should be used. The rate should be what is expected. If tax planning is being used, the low rate is likely applicable. ' The question indicates that the losses available for carry forward are provincial losses only, so a different rate would apply to the losses then to the other differences. The rate of selection is not always easy. Cine must interpret budgets. @ Copyright 11304 ICAD School of Atcmnnmtcy 1'11'31‘" I." F‘E‘l“ l," PP-B Handout Page 5 of 14 Calculation ofFuutre Income To: Asset (Lioofliw Cun‘ylng Tux Asset lsbtll Value Tax Busts Difference Rate FITA L Land 35,000 35,001} 0 Building 523,614 1,001,635 438,061 Equipment and office furniture 1,264,853 1,343,632 532,315 Equipment under capital lease 1,056,233 0 (1,056,283) Computer equipment 93,451 153,893 64,442 Vehicles 19,543 25,639 6,136 Leasehold improvements 11,203 1 1,203 0 Intangible asset 153,335 Non-taxable "' 153,335 0 Aoeounts receivable 1,85 5,901 *2,009,965 154,064 Obligation under capital 136,434 0 136,434 lease — eun'ent Obligation under capital lease — long term 932,149 0 932,142 1,333,354 41.62 533,463 Loss can]; forwards 0 1,046,000 1 046 000 12.5 130,350 Future loeome Tux Asset 3 295,213 FHA—Cunent $ 130 5,33 FITA— Long Term 5 533, 635 Implementation of the fitture' meome tastes will result to u futiue Income tax asset of $304,213. It must be assessed 11'sz future meome tax asset will be realized, and thus 1f1t should be recognized (refereuee S. 3465. 32). "Tux basis (See 3465. 14 example {fl} CBC balance 115,001 +25% ofearrying amount (25% x $153,335} 33,311 LEA-E *1 £55,901 + 206,21 1 —52,1 43 =2,009.965 El Comm-ight 2004 [CAO School officsuunmney PP — B Handout Page 6 of 14 The following arguments for and against recognizing the future income tax asset should be discussed: Arguments for recognizing the FITA Arguments against recognizing the FITA The losses available for carry forward do We would need to know if Aqua Saute has not expire for several years, and the history a history of tax losses or income tax of the entity indicate that the entity will reductions expiring unused. earn sufficient income to utilize the losses in the future. Existing sales contracts should produce It is unknown if Aqua Saute will he able to more than enough taxable income to realize expand into the Quebec market, and the future income tax asset. produce sufficient sales to realize the fiiture income tax asset. Amortization is correctly over $1,0flfl,{iflfl. CCA is significantly lower. The corporation could choose not to claim CCA in a given year, and utilize a portion of the losses available for carry forward. This could be considered a prudent and feasible tax strategy. There is currently insuflicient information to determine if the asset should be recognized or not. This would be an area of discussion with Roberto. |[flue option is for a portion of the future income tax asset to be recognized {i.e. the temporary differences), but not the losses available for carry forward portion, as it is currently undetenninable whether the “more likely than not" criteria has been achieved. In either situation, the current presentation of a deferred tax liability will likely no longer exist. It may be beneficial to Roberto, in his discussions for altemative financing, if there is a future income tax asset on the financial statements, compared to a deferred income tax liability. However, note that the bank has indicated that it would assess the corporation‘s ability to pay based on cash flow and EEITA. Presentation 3465.86 Income tax liabilities andI income tat assets slroulo!I be presented separately Jfrom other liabilities and assets. lIIZ'urreni income tax liabilities anel current income tax assets should be presented separately fi'om fitture income tax liabilities antlfiaure income tax assets. to Copyright 2004 lCAU School of Accountancy PP - El Handout Page i" of 14 B. Memo To Roberto With Recommendations on Differential Reporting flptions which would have a Favourable Dutconte {Including Calculation of Taxes Payable Disclosure) Areas where partial differentiation is possible include: - Accounting for subsidiaries that would otherwise be consolidated relates to new subsidiary, AMPL. and potentially new subsidiary in Quebec; - Accounting for equityr redeemable preferred shares issued in certain tax planning arrangements {applicable to ASI’s class A preferred shares}; - Accounting for income taxes on a tax payable basis, with additional disclosures instead of future income taxes; - Limited disclosure of the information required regarding authorized share capital; - Disclosure of the fair value of financial assets and liabilities whose fair values are readily obtainable: and - Testing for impairment of goodwill and other intangibles. Aqua Saute would be eligible for differential reporting because: - it is an entity with no public accountability; and - main concern would be to obtain unanimous consent. - When only certain owners have direct access to internal financial information, other owners' rights to financial information need to be considered separately. 1|When all of the owners of a non—publicly accountable enterprise agree on limited financial information needs, their decision influences the basis for financial reporting because it reflects the owner's assessment of the oosflbenefit trade-off specific to their enterprise. 1|bl-fi'itten unanimous consent of all owners {voting and non—voting} must be obtained. The written consent must specify the differential reporting options elected. Currently the users of the financial statements are: - Marcello and Maria — rely on the preferred shares to provide for their retirement income. No longer have the day-tohday contact with financial information, but may choose to have access if they choose; - Roberto — Chief Financial Officer; - Concetta — actively involved in the day to day operations, through marketing and advertising; and - Edwardo — interested in dividends only, viability and ability of the company to pay the dividends. He does not have access to internal financial information but he could if he chooses to. New users may he introduced such as: - Bank financing is being considered. As additional users of the financial statements, they are not owners, and thus their consent would not be required, however, they may require specific information not provided by the differential reporting standard Roberto should be made aware that the additional users may or may not agree to the financial statement presentation allowed under the differential reporting rules. Currently there is not a fi Copyright 200-1- ICAD School of Accountancy PP - B Handout Page 8 of [4 high degree of outside interest in the entity from outside investors, as all the current shareholders are family. However, if the banks and employees get involved, additional consent will be required. Changes to accounting policy note will be required: Effective January 1, EGGS, the company adopted the new recommendations of the Canadian Institute of Chartered Accountants pefiaining to differential reporting. As a result of retroactively applying the differential reporting options related to income taxes described in the summary of significant accounting policies, opening retained earnings as of January l, root and 20132 have been increased by $XX,XXX and $ XXJGiX respectively due to the de-recognition of the previously recorded deferred tax liabilities. Comparative figures for the year ended December 31, EDGE have been restated to reflect the retroactive application of differential reporting. Secretary of Significant A censoring Policies The company with the unanimous consent of its shareholders, has elected to prepare its financial statements in accordance with Canadian generally accepted accounting principles, using the differentialreporting options available to non~publicly accountable enterprises described below: a} Investment in Subsidiaries The company has elected to apply the differential reporting measurements option allowed for accounting for subsidiaries, and accordingly to account for its investments at cost (or using the equity method} b} Income Taxes The company has elected to apply the differential reporting measurement option allowed for income taxes and accordingly to account for income taxes using the taxes payable method under which the company reports as an expense of the year only the cost of current income taxes for that.year, determined in accordance with the rules established by taxation authorities. c} Financial Instruments The company has elected not to disclose fair value information about financial assets and liabilities for which fair value was not readily obtainable. The company has elected to apply the differential reporting recognition and measurement option allowed for preferred shares issued in tax planning arrangements, and accordingly present these shares as equity at their stated value, and any related dividends paid thereon as a charge to retained earnings. d] Share Capital The company has elected to not disclose terms and conditions related to classes of shares that have not been issued. lfi Copyright 2W4 [CAO School of Accountancy PP - B Handout Page 9 of 14 In addition, the report will be amended to identify that the financial statements have been prepared in accordance with the differential reporting requirements available to nun-publiclyr accountable enterprises, with the unanimous consent of its owners. Dwell-enlist repair-ring for redeemable preferred shares Without the current exemption the redeemable prefen'ed shares must be shown according to their substance, rather than their legal form and thus be shown as liabilities, rather than as equity. If the Class A preferred shares had to be reclassified as liabilities, they would be measured at fair value. In setting up the liability, the premium is reflected as a charge to retained earnings. When the differential reporting option with respect to redeemable preference share is adopted, the charge to retained earnings is made upon redemption or retraction. The fair value of the Class A preferred shares are $5,{lflfl,l}llll ($125 1: 40mm). The bank would not be as amicable to the idea of extending $51 a $3,003,0flfl line of credit, if there will already be such a large liability on the financial statements. ASI’s preferred shares qualify for differential reporting as they were issued under 3.85 of the Income Tax Act. Per 3860.96, equity preferred shares issued under Sections 51, 85, 85.1, Ed, 8? or 88 of the Income Tax Act {Canada} are eligible for the differential reporting option for preferred shares. Impact on ASI’s financial statements: - Share capital on the balance sheet would require 2 lines — one for preference shares, one for oonunon shares {3360.9T(a}}; - Must also indicate that shares are retractable by the holder (3359.9T(fl_}); Ir Must indicate total redemption value of all preferred shares on face of balance sheet (being $5,0flo,flflfl}. {386fl.9?{a}} As only one class of preferred shares issued no need to provide aggregate information by class {386G.9T{c}[i}); o Provide details of scheduled redemptions in next 5 years [38%.9T[c}[ii)}; I 2W4 —l,fli}flx5125or$125.l}0{l; i Need to discuss given terms, whether any other redemptions would consider to be scheduled; I Provide method of accounting for redemption of shares (3863.9?[c)(iii}); and I A premium of 5124,9011] will result which will be charged to retained earnings. Therefore, implementation of differential reporting will result in minimal change to the financial statement presentation of the redeemable preferred shares. Some additional disclosures are also required. Would recommend the differential reporting option for this, as the alternative would likely be detrimental in obtaining bani-t financing. It! Copyright EDD-4 IEAO School officeountancy PP - B I-Iandcut Page 10 of 14 Dwell-eerie! reporting for income taxes ASI must apply either the future taxes method or the income taxes payable method, permitted under Differential Reporting. The future income tax asset f liability method has already been calculated above. Under the taxes payable basis, ASI will report as its expense the cost {benefit} of income taxes for the period, based on taxation rules. Neither future income tax expense {benefit} or future income tax assets or liabilities will be recognized. Should AS] adopt the income taxes payable method, the following additional disclosures would be required: {i} a reconciliation of the income tax rate or expense for income before discontinued operations and extraordinary items to the statutory income tax rate or the amount that would result from its application, including the nature and amount of each significant reconciling item. Rate Expense Net income for the year $594,653 41.62% 24?,49? Amortization claimed for accounting purposes in excess o...
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