ACCOUNTING FOR INCOME TAXES



NAME _________________________________

INCOME TAX ACCOUNTING AND AUDITING

SPRING 2016

FINAL EXAMINATION

MAY 2016

THIS EXAMINATION CONSISTS OF EIGHT PROBLEMS WORTH A TOTAL OF 326 POINTS AND SIX MULTIPLE CHOICE QUESTIONS WORTH 24 POINTS EACH FOR A TOTAL OF 350 POINTS. THE POINTS FOR EACH PROBLEM ARE LISTED AT THE TOP OF THE PROBLEM.

YOU WILL HAVE TWO HOURS TO COMPLETE THE EXAM

Problem 1 (60 Points)

The following is the organizational chart for Elk, Inc. at December 31, 2015:

[pic]

For US GAAP purposes, Elk, Inc. produces consolidated financial statements that include the above entities in the group, including income for Wapiti, S.A., which is accounted for under the equity method by Elk, Inc. The remaining entities in the group are consolidated by Elk, Inc. Further Elk, Inc. has not elected to file consolidated returns for US Federal purposes for the group such that each of the US-based entities separately files their own tax returns.

For each of the following items discussed below, determine what deferred taxes at December 31, 2015, if any, should be recorded under ASC 740 in the US GAAP consolidated financial statements of Elk, Inc. Assume in all cases that a 40% tax rate applies at the Elk, Inc. level and that in each case there are no available tax free mechanisms for the return of any basis differences for the investments of Elk, Inc.

Also ignore any tax foreign tax credits that might be available to offset U.S taxes.

Tule, Inc.:

• 40% tax rate applies to this entity.

• At December 31, 2015, the book basis of investment of Elk, Inc.’s in Tule, Inc. is currently $10,000,000.

• At December 31, 2015, the tax basis of investment of Elk, Inc.’s in Tule, Inc. is currently $8,000,000.

• Elk, Inc. is asserting that the investment basis difference in Tule, Inc. is indefinitely invested and it will not need to draw funds out of Tule, Inc. in the future. This is a supportable position based on the information available.

• Further at December 31, 2015, Tule, Inc. has a book over tax basis difference in fixed assets due to tax accelerated depreciation of $1,000,000.

Provide the amount and nature (DTA or DTL) of the deferred taxes required under ASC 740 in Elk Inc.’s consolidated financial statements, if any, for Tule, Inc. at December 31, 2015:

_______________________________

______________________________

Muledeer, Gmbh:

• 30% local enacted statutory tax rate applies to this entity as it is a German corporation.

• At December 31, 2015, the book basis of Elk, Inc.’s investment in Muledeer, Gmbh is $5,500,000.

• At December 31, 2015, the tax basis of Elk, Inc.’s investment in Muledeer, Gmbh is $3,000,000.

• Elk, Inc. is asserting that the investment basis difference in Muledeer, Gmbh is indefinitely invested and it will not need to draw funds out of Muledeer, Gmbh in the future. This is a supportable position based on the information available.

• Muledeer, Gmbh has a reserve for book purposes for warranty claims that it records for US GAAP purposes that totals $3,000,000 at December 31, 2015. Warranty claims become deductible when paid for German corporate tax purposes.

Provide the amount and nature (DTA, DTL) of the deferred taxes required under ASC 740 in Elk, Inc.’s consolidated financial statements, if any, for Muledeer, Gmbh at December 31, 2015:

__________________________________

__________________________________

Wapiti, S.A.:

• 35% local enacted statutory tax rate applies to this entity as it is a French corporation.

• At December 31, 2015, the book basis of Elk, Inc.’s investment in Wapiti, S.A. is $4,000,000.

• At December 31, 2015, the tax basis of Elk, Inc.’s investment in Wapiti, S.A. is $2,000,000.

• Elk, Inc. is asserting that the investment basis difference in Wapiti, S.A. is indefinitely invested and it will not need to draw funds out of Wapiti, S.A. in the future. This is a supportable position based on the information available.

• Wapiti, S.A. has recorded for book purposes a deferred rent liability of $3,000,000 at December 31, 2015 representing the impact of straight-lining operating lease expense for US GAAP purposes for the lease payments to be made over the contractual lease term. The deferred rent liability has accumulated at December 31, 2015 given the cash payments under the lease have been lower to date than the corresponding straight-line lease expense for US GAAP purposes. For tax purposes, lease payments are deductible when paid in France.

Provide the amount and nature of the deferred taxes required under ASC 740 in Elk, Inc.’s consolidated financial statements, if any, for Wapiti, S.A. at December 31, 2015:

_____________________________

_____________________________

Problem 2 (40 Points)

The following information is provided for Montgomery Inc:

12/31/2014 12/31/2015

Taxable temporary differences $600,000 $800,000

Deductible temporary differences $500,000 $400,000

Valuation allowance $0 $100,000

Enacted tax rate 30% 40%

Total tax provision 2015 $150,000

Based on the above what is Montgomery’s taxable income for 2015?

___________________________________

Problem 3 (56 Points)

The following information is provided concerning Horizon Corp for the year 2015:

Book earnings before income taxes 6,000

Tax-exempt interest income 600

Taxes on foreign income above

the US statutory rate 200

State income taxes* 500

Net increase in warranty reserve

during 2014 200

Dividend received deduction 600

(amount of dividend income that

will never be subject to tax)

Federal FIN 48 expense booked in 2014 100

Foreign tax credits 400

Tax over book depreciation for 2014 500

*Before federal benefit

Based on the above information and assuming a 35% statutory rate prepare a rate reconciliation for 2015 showing the dollar amount of each reconciling item and the impact of each item on the effective tax rate.

Problem 4 (50 Points)

Connie’ Consolidated Containers Inc. (CCC) granted 1,000 nonqualified stock options to its president on December 31, 2012. The market value of the stock at the date of the grant was $20 per share which was also the option exercise price. The options vested 100% at the end of 2 years. The fair value of the option at the date of grant was determined to be $5. Assume the options were exercised on December 31, 2015 when the value of the stock was $22 a share. Also assume that paid-in-capital includes $900 of excess tax benefits relating to previous employee share-based payments granted subsequent to the effective date of statement 123(R). Finally assume that the company has a calendar year end and that the tax rate for all years is 40%.

Please complete the journal entries that would be recorded relative to these options in 2013, 2014 and 2015.

Now assume that the options were exercised on December 31, 2015 but that the price of the stock when the options on the exercise date was $28 per share. Please record the journal entries that would be required in 2015?

What would the entry be if the options expired unexercised in 2022 at the end of their life? (Assume all other entries were recorded correctly by the company)

Problem 5 (20 Points):

During 2015, D Company, Inc. a Delaware C corporation entered into a settlement with the Department of Justice and the FTC in connection with alleged charges of price fixing in its energy distribution businesses. Under the agreement, D Company is required to pay $25 million which was paid in 2015 and will be deducted as part of the 2015 tax return. The $25 million was specified in the agreement as having both the elements of being a fine and a disgorgement of ill-gotten profits however the agreement was unclear as to the amount of each. Under the US tax code a fine would not be deductible but a disgorgement of profit would be. In evaluating the position under ASC 740 / FIN 48 in connection with the preparation of the 2015 financial statements, you have been provided the following information:

• A number of companies have attempted to deduct amounts paid under similar settlement agreements and have been successful arguing that portions of the amounts paid relate to a disgorgement of profit. One such case occurring in 2015 went to the Supreme Court which upheld the taxpayer position that the entire amount was a disgorgement. That situation you understand had much clearer language supporting the disgorgement position than the D Company settlement agreement.

• In consulting with a reputable leading corporate tax attorney used by the Company you understand that they believe that in the D Company situation that they would be able to arrive at a more likely than not opinion that the entire amount of the $25 million would be considered a disgorgement that is deductible based on technical merits.

• The tax attorney believes it is unlikely the amount would be challenged by the IRS given the recent Supreme Court ruling in the area but if it were the IRS would challenge that some portion of the amount is a fine and not a disgorgement resulting in potentially lengthy and costly process to defend the position. You have, however, been provided the following information by the Company after discussing with their tax counsel regarding the possible outcomes if the item was challenged:

|Outcome |Individual Probability of Occurring |

|100% of the $25 million payment is considered a disgorgement. |10% |

|75% of the $25 million payment is considered a disgorgement. |15% |

|50% of the $25 million payment is considered a disgorgement. |25% |

|20% of the $25 million payment is considered a disgorgement. |30% |

|0% of the $25 million payment is considered a disgorgement. |20% |

Using the information above and ignoring the impact of state taxes, penalties and interest, and assuming the tax rate applicable to D Company is 35% determine the ASC 740 / FIN 48 entries required to be recorded for the $25 million position in the 2015 financial statement

Problem 6 (55 Points)

Attached are the financial statements and the income tax footnote included in the recent Form 10-K for a large public company. Certain balances have been excluded from these statements and footnote and are identified with a bold box around the item missing.

Using only the information provided in the accompanying financial statements and footnote, fill in the missing amounts identified with a box in the accompanying financial statements and footnotes.

There are 11 of these open box items to be completed by you in connection with this question.

THE COMPANY

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)

| | | | |

|  |  |2015 | |2014 | |2013 | |

|Revenues |  |$ |3|  |$|4,235,223 | |

| | | |,| | | | |

| | | |6| | | | |

| | | |2| | | | |

| | | |0| | | | |

| | | |,| | | | |

| | | |5| | | | |

| | | |8| | | | |

| | | |0| | | | |

|Operating Costs and Expenses: |  |  | |  | |  | |

|  |  |Total | |  |3|  | |

| | |operating | | |,| | |

| | |costs and | | |5| | |

| | |expenses | | |1| | |

| | | | | |0| | |

| | | | | |,| | |

| | | | | |3| | |

| | | | | |4| | |

| | | | | |6| | |

|Operating income |  |  |1|  | |96,670 | |

| | | |1| | | | |

| | | |0| | | | |

| | | |,| | | | |

| | | |2| | | | |

| | | |3| | | | |

| | | |4| | | | |

|Income before provision for income taxes |  |  |8|  | |54,854 | |

| | | |6| | | | |

| | | |,| | | | |

| | | |7| | | | |

| | | |3| | | | |

| | | |8| | | | |

|  |  |Net income | |$ |7|  |$|

| | | | | |9| | |

| | | | | |,| | |

| | | | | |1| | |

| | | | | |6| | |

| | | | | |6| | |

|Basic net income per share |  |$ |0|  |$|0.50 | |

| | | |.| | | | |

| | | |7| | | | |

| | | |8| | | | |

|Diluted net income per share |  |$ |0|  |$|0.49 | |

| | | |.| | | | |

| | | |7| | | | |

| | | |7| | | | |

|Basic weighted average shares outstanding |  |  |1|  | |103,101 | |

| | | |0| | | | |

| | | |1| | | | |

| | | |,| | | | |

| | | |8| | | | |

| | | |5| | | | |

| | | |2| | | | |

|Diluted weighted average shares outstanding |  |  |1|  | |104,897 | |

| | | |0| | | | |

| | | |2| | | | |

| | | |,| | | | |

| | | |7| | | | |

| | | |1| | | | |

| | | |3| | | | |

|Cash dividends per share |  |$ |0|  |$|0.42 | |

| | | |.| | | | |

| | | |4| | | | |

| | | |4| | | | |

.THE COMPANY

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

| | | | | | | | | | |

|  | |2015 | |2014 | |

|ASSETS | |  | |  | |

|  | |Total | |  |3|

| | |current | | |6|

| | |assets | | |9|

| | | | | |,|

| | | | | |2|

| | | | | |1|

| | | | | |5|

|Property and Equipment: | |  | |  | |

| | |  |2|  | |

| | | |,| | |

| | | |4| | |

| | | |4| | |

| | | |2| | |

| | | |,| | |

| | | |4| | |

| | | |1| | |

| | | |3| | |

|  | |Net | |  |1|

| | |property | | |,|

| | |and | | |4|

| | |equipment | | |0|

| | | | | |0|

| | | | | |,|

| | | | | |3|

| | | | | |5|

| | | | | |2|

|Other Assets: | |  | |  | |

|  | |Total | |  |1|

| | |other | | |7|

| | |assets | | |9|

| | | | | |,|

| | | | | |3|

| | | | | |8|

| | | | | |0|

|  | |Total | |$ |1|

| | |assets | | |,|

| | | | | |9|

| | | | | |4|

| | | | | |8|

| | | | | |,|

| | | | | |9|

| | | | | |4|

| | | | | |7|

|LIABILITIES AND SHAREHOLDERS' EQUITY | |  | |  | |

|  | |Total | |  |4|

| | |current | | |0|

| | |liabilitie| | |8|

| | |s | | |,|

| | | | | |8|

| | | | | |8|

| | | | | |2|

|Long-term debt, less current installments | |  | |  | |

| | | |7| | |

| | | |2| | |

| | | |7| | |

| | | |,| | |

| | | |4| | |

| | | |4| | |

| | | |7| | |

| | |  |2|  | |

| | | |,| | |

| | | |3| | |

| | | |1| | |

| | | |5| | |

| | | |,| | |

| | | |9| | |

| | | |1| | |

| | | |2| | |

|  | |Total | |  |6|

| | |shareholde| | |4|

| | |rs' equity| | |6|

| | | | | |,|

| | | | | |9|

| | | | | |2|

| | | | | |4|

|  | |Total | |$ |1|

| | |liabilitie| | |,|

| | |s and | | |9|

| | |shareholde| | |4|

| | |rs' equity| | |8|

| | | | | |,|

| | | | | |9|

| | | | | |4|

| | | | | |7|

See accompanying notes to consolidated financial statements. HINT: INCLUDE BOTH CURRENT AND NONCURRENT DTA AND DTLs

INCOME TAXES

        The provision for income taxes consists of the following (in thousands):

| | | | | | | | |

|Current income tax expense (benefit): |  |  |  |  |  |  | |

|  |  |Total current |  |  |(40|) | |

| | |income tax expense | | |,34| | |

| | |(benefit) | | |6 | | |

|Deferred income tax expense (benefit): |  |  |  |  |  |  | |

|  |  |Total deferred |  |  |47,|  | |

| | |income tax expense | | |918| | |

| | |(benefit) | | | | | |

| |  |$ |7,|  |$ | . | |

| | | |57| | | | |

| | | |2 | | | | |

        A reconciliation between the reported provision for income taxes and the amount computed by applying the statutory Federal income tax rate of 35% to income before provision for income taxes is as follows (in thousands):

| | | | | | | | |

|Income tax expense at statutory rate |  |$ | |  |$|19,197 | |

| | | |. | | | | |

| |  |$ | .|  |$|3,132 | |

    

The income tax effects of temporary differences that give rise to significant portions of deferred income tax assets and liabilities as of June 24, 2015 and June 25, 2014 are as follows (in thousands):

| | | | | | | | | | |

|  |  |2015 | |2014 | |

|Deferred income tax assets: |  |  | |  | |

|  |  |Total | |$ |1|

| | |deferred | | |1|

| | |income tax | | |6|

| | |assets | | |,|

| | | | | |1|

| | | | | |2|

| | | | | |1|

|Deferred income tax liabilities: |  |  | |  | |

|  |  |Total | |  |6|

| | |deferred | | |9|

| | |income tax | | |,|

| | |liabilities | | |6|

| | | | | |3|

| | | | | |1|

|  |  |Net deferred| |$ |4|

| | |income tax | | |6|

| | |asset | | |,|

| | | | | |4|

| | | | | |9|

| | | | | |0|

        At June 24, 2015, we had approximately $18.2 million of U.S. Federal general business credit carryforwards. These tax credits will expire in fiscal 2034. It is anticipated that these credits will be fully utilized prior to their expiration.

Problem 7 (45 Points)

The following three multiple choice questions relate to the following facts: In Wily Coyote’s 2015 financial statements, WC has three tax issues that have been identified as having some risk. Information about these issues is presented in the table below. Note: the possible outcomes represent tax benefit numbers with the top number for each issue representing the amount of benefit claimed on the tax return.

|Issue A: Whether Wily is entitled to |Issue B: Whether interest received on a |Issue C: Whether compensation paid to |

|claim foreign tax credits for taxes paid |City of Las Vegas bond, the proceeds of |Wily’s CEO is “reasonable”. [If not, it is |

|to a foreign country. |which were used to construct a casino, is |a non-deductible dividend.] |

| |exempt from tax. | |

|Possible Outcome |Individual |Possible Outcome |Individual |Possible Outcome |Individual |

| |Probability | |Probability | |Probability |

|$400,000 |0 |$250,000 |20% |$1,200,000 |0 |

|$300,000 |50% |$200,000 |20% |$720,000 |60% |

|$0 |50% |$150,000 |20% |$360,000 |40% |

| | |$100,000 |20% | | |

| | |$0 |20% | | |

1. With respect to Issue A, the required liability for unrecognized tax benefit would be

a. $400,000

b. $300,000

c. $100,000

d. $0

2. With respect to Issue B, the required liability for unrecognized tax benefit would be

a. $250,000

b. $200,000

c. $150,000

d. $100,000

e. $50,000

3. With respect to Issue C, the required liability for unrecognized tax benefit would be

a. $1,200,000

b. $840,000

c. $720,000

d. $480,000

e. $360,000

Problem 8 (24 Points)

1) The term “intraperiod tax allocation refers to the process that allocates total income tax expense or benefit of an entity for a period to different components of comprehensive income and shareholders' equity. This includes allocating income tax expense or benefit for the year to all of the following except

a. Continuing operations

b. Extraordinary items

c. Other comprehensive income

d. All of the above

2) The tax effect of which of the following would not be allocated to income or loss from continuing operations

a. Changes in circumstances that cause a change in judgment about the realization of deferred tax assets in future years

b. Changes in tax laws or rates

c. Unrealized gains and losses on securities held for investment

d. Changes in tax status

3) Which of the following would likely not be a consideration in determining if an investment “is essentially permanent in duration”?

a. Need for the assets in the foreign jurisdiction

b. Ability to shift resources to other foreign locations without U.S. taxation

c. Intent of management

d. All of the above

4) ASC 740-10-25-3 provides that a deferred tax liability is not recognized for the certain types of temporary differences unless it becomes apparent that those temporary differences will reverse in the foreseeable future. One of the temporary differences covered by this section is the amount for financial reporting over the tax basis of an investment in a foreign entity that is essentially permanent in duration. This exception does not apply to:

a. Foreign subsidiaries

b. Foreign joint ventures

c. Outside basis differences

d. Inside basis differences

.

5) Which of the following would not be considered a “tax position”?

a. A decision not to file a tax return

b. An allocation or a shift of income between jurisdictions

c. The characterization of income or a decision to exclude reporting taxable income in a tax return

d. All of the above would be considered tax positions

6) Under ASC 740-10-50-6 A public entity shall disclose the approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets (before allocation of valuation allowances). The same rules apply for a non public enterprise except that

a. A non public enterprise does not need to consider carryforwards

b. A non public enterprise may omit disclosure of the tax effect of each type of temporary difference and carryforward

c. A non public enterprise can group all deferred tax assets and deferred tax liabilities together

d. None of the above

-----------------------

ELK, INC.

(C CORP

US PARENT)

TULE, INC.

(US C CORP)

60% OWNED BY ELK, INC., 40% OWNED BY UNRELATED PARTIES

MULEDEER, GMBH (GERMAN CORPORATION)

100% OWNED BY ELK, INC.

JACKSON, INC. (US C CORP)

100% OWNED BY ELK, INC.

WAIPITI, S.A.

(FRENCH CORPORATION)

30% OWNED BY ELK, INC., 70% OWNED UNRELATED ENTITIES

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