Chapter 13 - Solution Manual

Thus for 2011 bayshore will report 254776 2254776

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Thus, for 2011, Bayshore will report $2,547.76 (22,547.76 - 20,000) more earnings before tax than will Dagger. b. Total lease related expenses reported by Dagger in 2011 are calculated in a. as $22,547.76. Dagger will deduct 20,000.00 for tax purposes, creating a temporary difference of $2,547.76 - a future deductible amount. The result is a deferred tax asset for 2011 of $1,019.10 ($2,547.76 x 40%). Because Bayshore treats the lease as an operating lease for both tax and accounting purposes, there are no temporary differences and no deferred taxes. c. For 2011, Dagger will have no cash flows from operating activities relating to the lease other than the tax shield from the $20,000 lease payment. If the indirect method is employed to report cash flows from operating activities, the interest expense and depreciation expense would be added to net income, and the increase in the deferred tax asset would be subtracted. Bayshore would report a $20,000 operating cash outflow under the direct method of reporting cash flows from operating activities. Because this amount is reported as an expense in the income statement, no adjustment would be needed under the indirect method. d. Because Dagger treats the lease as a capital lease, the leased asset is presumed purchased. According to SFAS No. 95 (FASB ASC 230), cash outflows incurred to purchase a productive resource are considered investing activities. Hence, the initial $20,000 payment will be reported as an investing outflow. The amount financed ($66,242) will appear as supplementary information because it represents an investing and financing activity not affecting cash. Because Bayshore treats the lease as an operating lease, the leased asset is not presumed purchased. Hence, the $20,000 initial lease payment is not an investing outflow. Bayshore would report nothing related to the lease as an investing activity. e. Bayshore will not report any financing activities in 2011 due to the lease. In 2011, Dagger will report the amount of payment which reduces the loan balance ($20,000 - $5,299.36) as a financing outflow. f. The only cash flow for either company in 2011 is $20,000. Hence, the effect on total cash flows for both companies in 2011 is $20,000.
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278 g. Reporting the lease as an operating lease has the disadvantage of keeping assets off the balance sheet and the advantage of not reporting the associated liability. An advantage is a smoothed effect on the income statement. Also, less expense is recognized earlier. An adverse effect, is that operating cash flows are lower each year by the difference between the lease payment and any interest payment made. In this case, it also reduces the positive effect of deferred taxes from the balance sheet and income statement. Reporting the lease as a capital lease increases assets. In this case, fixed assets are increased and there is a deferred tax asset. However, the liability must be recognized. Also, expense recognition, net of deferred tax effects, is accelerated in the income statement. At the same time, operating cash flows are improved because they only include payments for interest. Additionally Dagger will report depreciation on the leased asset on its income statement.
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