For the Year Ended...

[Griet van Vliet]

After a harrowing personal tax season, where she worked very long hours until the deadline for filing arrived, Griet was more than happy to see some corporate files once again. At the beginning of the year, Tabder's Radiation Launchers had the following equity: Common shares, unlimited number authorized, 100,000 shares issued and outstanding, 270,000, Contributed surplus 310,000, Retained earnings 2,300,000. That doesn't sound like a company about to be expropriated, she thought, while realizing that, typically, an entire company that is about to be expropriated (as opposed to property) typically have large litigation provisions for liabilities. The following transactions occurred during the year: 12,000 subscriptions were sold for 26/share. The first payment was for 10/share. Dr. Subscription shares receivable 192,000, Dr. Cash 120,000, Cr. Subscription shares 312,000. The final payment was for 16/credit of which 2,000 defaulted, Dr. Cash 160,000, Cr. Subscription shares receivable 160,000, Dr. Subscription shares 52,000, Cr. Subscription shares receivable 32,000, Cr. Contributed surplus 20,000. Oops. Dr. Contributed surplus 20,000, Cr. Accounts payable 20,000.

 

[Griet van Vliet]

Now, they bought back 22,000 shares at 29/share. Cr. Cash 638,000, but what were the debits? On average, they were worth, on the books, 4.82/share, so Dr. Common shares 106,040, Dr. Contributed surplus 310,000, Dr. Retained earnings 221,960. (If, instead, the defaulted subscribers couldn't get refunds, the only change would be the contributed surplus and retained earnings, with the difference being pro-rated against the total number of out-standing shares, so 4,000 more in contributed surplus). Dr. Cash 300,000, Cr. Common shares 93,000, Cr. Preferred shares 207,000. And even then they had not declared dividends, nor made a profit (despite the problems plaguing them that were making them edge closer to expropriation with each passing day) or even losses. Before the next client could even think of declaring dividends, they would need to know whether or not it's worthwhile to change the percentage on preferred dividends, so that they would be able to make a decision accordingly. Because their effective tax rate was 24%, it would be a factor in any diluted EPS calculation.

 

[Griet van Vliet]

The baseline EPS calculations would assume an after-tax profit of 400,000, 60,000 common shares outstanding all year, 100 convertible bonds at 10% interest rate, each of them being convertible into 25 bonds, and 500 preferred shares at 5% dividend, each convertible into 2 common shares. The basic EPS would be made based on an income of 397,500, so 6.63. Now, a diluted EPS would assume all of that stuff is converted, provided the incremental EPS isn't equal or higher than the basic (they'd be called anti-dilutive otherwise). If the bonds are converted, they would be saving 10,000*76% = 7,600 of interest, spread over 2,500 shares, so at 3.04 they are dilutive. As for the preferred shares, they would be saving 2,500 in dividends over 1,000 shares; at 2.50, they are dilutive as well. And now 407,600 over 63,500 shares: the diluted EPS becomes 6.42. But, if the dividend rate became 14%, the preferred shares become anti-dilutive and hence ignorable, the basic EPS becomes 6.55 and the diluted EPS becomes 6.41. There is one more thing that ought to be disclosed: litigation.

 

[Griet van Vliet]

Litigation... the verdict rendered by the court today ruled the conversion of 40% of the bonds, made at the very beginning of the second quarter, legal. The company was the defendant. The diluted EPS would remain the same, at 6.42, but the weighted shares outstanding would be 60,750 since 1,000 shares were extant only for 3/4 of the year. Which also meant they were saving 3,000 in interest for tax purposes, which also put 2,280 in their pocket for financial reporting purposes, but the litigation expenses were already accounted for before the verdict was rendered. The defendant was not ordered to pay the legal fees of the plaintiff, so the basic EPS was 6.58. It isn't a coincidence that diluted EPS remains the same regardless of whether the securities are converted or not: the assumption was that the conversion was made at the very beginning of the year. Or, if there were put options (call options are ignored because in-the-money call options are antidilutive), the option would be exercised at the very beginning too, and the incremental number of shares would then be the difference between the # of options and the # of shares purchaseable at the average market price for the year.

 

[Griet van Vliet]

Oops. For some reason, there were tons of clients in former CSA-land that somehow decided to deal with VPN in Wild Space. Much like the Stone River Textile Mill. They had taxable temporary differences of 2.2 million and a deferred tax liability of 616,000 on their balance sheet. For this year and future years, the tax rate enacted was changed to 30%. For the last year, the Stone River Textile Mill's accounting loss before tax was 494,000. The following data was also available: pension expense was 87,000 while pension plan contributions were 111,000, business meals and entertainment was 38,000 (half-deductible for tax purposes), the total taxable income in the past three years was 123,000 with the total tax expense for those three years was 51,660, the warranty expense was 31,000, it incurred 150,000 in development costs of which half is tax-deductible, it is estimated half of the loss carry-forward could be realized, if any, and depreciation expense was the same as their equivalent to Talz CCA. So the question was to prepare these guys' journal entries related to taxes, and also their tax returns.

 

[Griet van Vliet]

The starting point of the tax return is the reconciliation. 494,000 - 87,000 + 111,000 - 31,000 and 94,000 in permanent differences that increase taxable income. The taxable loss is thus 393,000. Of which the full 123,000 was carried back and it was pretty straightforward to write the journal entry, given the erroneous data about the income tax expenses incurred (which should have read 34,440 rather than 51,660): Dr. Income tax receivable 34,440, Cr. Current tax benefit 34,440. There's 270,000 left, of which there is 135,000 only that is expected to be realized. So Dr. Deferred tax asset 81,000, Cr. Deferred tax benefit 40,500, Cr. Allowance to reduce deferred tax asset to expected realizable value 40,500. But also Dr. Deferred tax expense 44,000, Cr. Income tax payable 44,000, so there's also the decrease in temporary differences of 7,000, from there Dr. Deferred tax expense 2,100, Cr. Deferred tax liability 2,100. Conclusion: the actual income tax benefit for the year is 33,040. A refund of 34,440 isn't much of a balm, but better than nothing. And permanent differences bit them in the behind this year around.

 

[Griet van Vliet]

Hass Foods Inc sponsors a post-retirement medical and dental benefit plan for its employees. The company made the switch to IFRS in preparation for tis IPO effective at the start of last year (they hired VPN for a pre-IPO audit, and they may as well buy shares as a short-term investment). At the start of their first IFRS year their plan assets were 2.78 million, their DBO was 3,439,800, and accrued no past service costs. The service cost for the last year ended was 273,000, the discount rate is 7%, funding payments were 234,000, the actual return on plan assets as 158,500 and the benefits paid out to retirees was 171,600. The post-retirement benefit expense must be calculated first (even though, for tax purposes, only the 234,000 contributed was deductible) so that's the sum of net interest cost, current and past service costs. Which means (3,439,800-2,780,000)*7% = 46,186 + 273,000 = 319,186. Now to know what actually goes in the OCI portion, since there are no actuarial losses incurred: 194,600 - 158,500 = 36,100 as a loss on asset remeasurement. The net "pension expense" is therefore 355,286.

 

[Griet van Vliet]

She would therefore expect the deficit to increase by 355,286 - 234,000 = 121,286. The continuity schedule for the pension plan's assets was pretty straightforward to make: 2,780,000 + 158,500 + 234,000 - 171,600 = 3,000,900. As for the liability: 3,439,800 + 240,786 + 273,000 - 171,600 = 3,781,986. The really big difference between a post-retirement medical plan and a regular defined benefit pension plan is that the payout has a lot more uncertainty surrounding it. They had no choice whatsoever as to put the remeasurement and actuarial gains and losses in OCI. Also, two-thirds into the year, they entered into a capital lease with an unguaranteed residual value of 9,000, the yearly rent is 13,668, with an estimated life of six years and an implicit interest rate of 10%, which is also their incremental borrowing rate. The fair value is 79,000. The capitalized value is hence 56,993.65. Dr. Right-of-use asset 56,994, Cr. Obligations under lease 56,994, Dr. Obligations under lease 13,668, Cr. Cash 13,668, Dr. Interest expense 1,444, Cr. Interest payable 1,444, Dr. Depreciation expense 3,800, Cr. Accumulated Depreciation 3,800.

 

[Griet van Vliet]

Now there was one more thing a client, based out of Adarlon, wanted to clear up when making the decision of whether or not to enter a new market: they know the item will sell for 750 credits on Townowi, but the item is manufactured on Adarlon. The Adarlon active business income tax rate is 40% for corporations, and on Townowi, that rate is 44%. Plus the Townowi tax authorities have advised the client it will only accept a transfer price between the full manufacturing cost of 500 (although the client supplied the variable expenses of 350/unit, she does not feel it is of any tax planning relevance; on Adarlon, the determination of active business income for tax purposes requires absorption costing) and 650, and an import duty of 10% is levied on Townowi, which is countable against active business income on Townowi. They want to minimize the tax liability, and that's understandable. But taking a transfer price of 500 means there is no active business income earned on Adarlon, and 200 on Townowi; the tax liability is hence 138/unit. One last thing: the company is fiscally resident of neither planet and is therefore taxed on both planets only on income earned on those planets.

 

[Griet van Vliet]

Since payroll taxes are tax-deductible on Adarlon (the employer does not contribute anything but the amounts withheld from the employee's paycheck, of which the gross amount is tax-deductible, even though the employee receives only a check for the net amount), the total tax liability as a function of the transfer price is therefore 0.4(x-500) + 0.1x + 0.44 (750-1.1x), or 0.4x-200+0.1x+330-0.484x. Or 0.016x + 130. Alternatively, if the client instead chooses to use a transfer price at 650, the company would pay 60 credits/unit on Adarlon, 65 in duty on Townowi and 15.40 to the Townowi tax authorities, for a total tax liability of 140.40, so because of duty considerations, it would be best for the client to transfer the merchandise at cost. On the other hand, if the vendor's tax rate is above (a+b)/(1+b ), where a is the manufacturer's tax rate, excise included, and b is the duty rate, it is better to have as much revenue accrued in the manufacturer's jurisdiction as possible, but here the reverse is true and hence the client should accrue as much revenue as possible on Adarlon.

 

[Griet van Vliet]

The Red Deer Company meat cleaning department, under new management, hired them to help out with spoilage, which was a new area for the manager. At the beginning of the day, there was 2,500 kg of meat under WIP, with 2,500 in direct materials (100% complete as to costs) and 2,000 in conversion costs (80% complete as to costs), and 22,500 kg started during the month, with 18,500 kg transferred out in good units, and a 4,000 kg WIP ending inventory, 100% complete for materials (meat-packers add materials at the beginning, but 25% complete for conversion costs), with total costs added during the day of 22,500 for raw meat and 20,000 for conversion costs, and 10% as normal spoilage, with normal and abnormal spoilage being 100% complete on both counts. The thing was to use both weighted-average and FIFO. Step one of the production cost report: doing the physical unit flow reconciliation. So one needs to account for 25,000 kg for materials, of which 4,000 is still WIP, and past managers indicated that normal spoilage is about 10% of the good units, so 1,850 is normal spoilage, and the remainder is abnormal spoilage. 650 kg is therefore abnormal spoilage. Next, one needs to consider the cost per equivalent unit.

 

[Griet van Vliet]

Under weighted-average assumption, the direct materials is 25,000, but conversion costs are 22,000 since the ending WIP is 25% complete for conversion costs; however, under FIFO, 16,000 is started and completed as good units, 2,500 in spoilage, and 4,000 as WIP, for 22,500 in materials, but for conversion costs: 500 kg of WIP was finished today, 18,500 was started and finished today, and only 1,000 so 20,000 total under FIFO. The difference being that normal spoilage is part of costs transferred out, but abnormal spoilage isn't. The costs incurred to date (for weighted-average) are therefore 25,000 for materials and 22,000 for conversion costs, 1 credit per equivalent unit in each case. So there's 1,300 in abnormal spoilage, 5,000 in the ending WIP and 40,700 in the cost of units completed and transferred out, under weighted-average. Under FIFO, the cost per equivalent unit is, once again, 1 credit/equivalent unit, and the beginning WIP balance is 4,500. Add 500 in conversion costs, 32,000 in good units, and 3,700 in normal spoilage, and the result is still 40,700 transferred out. They're the same but I may not be so lucky next time, she thought.

 

[Griet van Vliet]

Two companies, Newstar and PLX, signed an agreement whereby the operations of PLX are to be taken over by Newstar. PLX is to liquidate after the transfer is complete, whereby Newstar is buying all the assets minus cash. The appraiser's report just arrived and took on the form of a comparative balance sheet, assuming both follow IFRS even though neither may actually need to:

Newstar and PLX​

Comparative balance sheets​

​

Cash (Newstar: 50,000, PLX: 20,000)
Accounts receivable (Newstar: 75,000, PLX: 56,000)
Inventory (Newstar: 56,000, PLX: 29,000)
Land (Newstar: 65,000)
PP&E (Newstar: 180,000, PLX: 167,000)
Less: Accumulated depreciation (Newstar: 60,000, PLX: 40,000)
Investment in Sefton (PLX: 26,000)
Bonds in Akaroa (Newstar: 10,000)

Total assets: (Newstar: 376,000, PLX: 258,000)

Accounts payable (Newstar: 62,000, PLX: 31,000)
Notes payable (Newstar: 75,000, PLX: 21,500)
10% bonds (Newstar: 100,000, PLX: 30,000)
Share capital:
Common shares (Newstar: 100,000)
A class shares of $2 (PLX: 40,000)
B class shares of $1 (PLX: 60,000)
Retained earnings (Newstar: 39,000, PLX: 75,500)

Total liabilities and equity: (Newstar: 376,000, PLX: 258,000)

 

[Griet van Vliet]

Yet, under IFRS, when one buys a business by way of buying assets, one does not buy assets at their book values unless no fair values could be ascertained. So the fair values of PLX are the following: Inventory: 39,200, PP&E: 140,000, Investment in Sefton: 22,500. Now for the consideration paid: the class A shareholders (20,000 shares), receive one 7% debenture for every share, at 3.50 each, and class B shareholders (60,000 shares) receive 2 shares in Newstar for every 3 shares held in PLX, at 2.70 each, costing 900 to issue. Additionally, Newstar is to provide PLX with enough cash to pay off the liabilities, with the bonds being redeemed at a 10% premium. Annual leave entitlements at 16,200 and also liquidation costs of 5,000 that were not recognized by PLX, and finally costs to transport and install PLX's assets at Newstar's premises will be 1,600. First part: calculate the total consideration. The equity portion is 178,000, and the cash portion is: 31,000 for A/P, 21,500 for the mortgage, 33,000 for the bond, 5,000 for liquidation and 16,200 for the annual leave entitlements, less the 20,000 cash balance, for a total cash outlay of 86,700 and the total consideration is 264,700. But that has to be counted against the FV of what's paid and, since they are both incorporated on D'Qar, a planet that has no business tax, there are no tax consequences to this, on the acquiree or the acquirer. 56,000+39,200+140,000+22,500 = 257,700 and the goodwill is therefore 7,000.

 

[Griet van Vliet]

Because Newstar has no cash left (and even has to take out a bank overdraft) there is no cash at the top of the asset portion of the consolidated balance sheet. But that didn't prevent the expensing of 1,600 because it's not an individual asset being bought, otherwise that 1,600 would have to be capitalized. And expensing it meant that R/E was going to be debited for 1,600.

​

Newstar​

Consolidated balance sheet​

Accounts receivable 131,000
Inventory 95,200
PP&E 320,000
Less: Accumulated depreciation (60,000)
Land 65,000
Investment in Sefton 22,500
Bonds in Akaroa 10,000
Goodwil 7,000

Total assets: 590,700

Bank overdraft 36,700
Accounts payable 64,500
Notes payable 75,000
Debentures 70,000
Share capital 207,100
Retained earnings 37,400

Total liabilities and equity 590,700

 

[Griet van Vliet]

For a while, Griet was happy to be working on a different floor from that Talz accountant that, while an expert on CCA, was only really working on the CCA consequences of M&A now that the Talz tax season was over. Today's client was being audited for the second quarter's financial statements, and the client was unsure of which method to use for allocating the costs of support departments. The client told VPN that they are allowed either direct or step methods for allocating their expenses, with pre-allocation overhead expenses being the following for said quarter, neatly presented with their usage of the presumed cost drivers (machining's is MH and assembly's is DLH, but Griet preferred activity-based costing to that sort of stuff; the choice of an overhead allocation method is irrelevant even though, under IFRS, manufacturing overhead must be accounted for under absorption costing):

Department | Utilities | Maintenance | TM | Machining | Assembly
Pre-allocation costs | 800000 | 650000 | 400000 | 1230000 | 370000
Power usage (kWh) | 800 | 1200 | 500 | 33300 | 35000
Square meters | 1000 | 1000 | 1000 | 40000 | 5000
Workforce (ppl) | 12 | 21 | 15 | 147 | 20
Machine hours | Nil | Nil | Nil | 500000 | 10000
Direct labor hours | Nil | Nil | Nil | 250000 | 60000

Under the direct method (all of the support expenses are allocated to manufacturing depts):

Utilities | 390043.92 | 409956.08
Maintenance | 577777.78 | 72222.22
TM | 352095.81 | 47904.19
Total expenses | 2549917.51 | 900082.49
Costs per MH: 5.10
Coss per DLH: 15.00

 

[Griet van Vliet]

One could try using the reciprocal method, whereby it is acknowledged that all support departments support not only the production departments, but also each other, and yet, in practice, it requires knowledge of matrix algebra to carry out for more than two support departments, the Gauss-Jordan method to be more precise. The difference here, under the step-method, one would need to rank the support departments. The above stipulation gives

Department | Maintenance | TM | Machining | Assembly
Utilities | 13714.29 | 5714.28 | 380571.43 | 400000
Maintenance | Nil | 14428.57 | 577142.86 | 72142.86
TM | Nil | Nil | 369826.34 | 50316.51
Total expenses | Nil | Nil | 2557540.63 | 892459.37
Cost per MH: 5.11
Cost per DLH: 14.87

 

[Griet van Vliet]

That Talz accountant, while an expert in CCA, handed her one of the more troublesome files, from a new client (or rather from a pair of clients; Oakridge also hired VPN to get Ventnor's accounting done, too) that chose to stay with VPN because the old accounting firm they used was bought by VPN. It has been five years since Oakridge bought Ventnor; Ventnor's balance sheet showed the following at the start of those five yeras:

Land 20000
PP&E 100000
Inventory 15000

Total assets 135000

Liabilities 15000
Share capital 60000
Retained earnings 60000

Total liabilities and equity 135000

However, the appraiser's report dated the day of that balance sheet indicated that the PP&E's fair value was 102000 and the inventory's fair value was 18000, and the PP&E had a future life of five years as at that date. For all these years, Manpha's corporate tax rate was 30%. So the retained earnings adjustment from selling all the inventory within a year, and 80% of the lifespan of the PP&E are respectively 2100 and 1120, downward, with 120 less in tax expense, but also 400 more in depreciation expense, Griet thought, while wondering just how much consideration was actually transferred on that day since she ought to remove it when preparing the consolidated balance sheet.

 

[Griet van Vliet]

Now, for goodwill purposes, the tax liabilities must be netted against the FVA; she's grateful for Manpha not having any accelerated depreciation system for tax purposes, CCA and other systems she knew were in use in the galaxy. The answer to that question would be found in the segmented financial statements:

Company | Oakridge | Ventnor
EBIT | 100000 | 15000
Income tax expense | 20000 | 5000
Profit for the year | 80000 | 10000
Beginning retained earnings | 133000 | 64000
Ending retained earnings | 213000 | 74000
Share capital | 445000 | 60000
Liabilities | 42000 | 4000

Total liabilities and equity | 700000 | 138000

Land | Nil | 20000
PP&E | 571000 | 95000
Inventory | 15000 | 23000
Investment in Ventnor | 114000 | Nil

Total assets | 700000 | 138000

So it was a bargain purchase, since the total net assets is 123500 and the total consideration transferred is only 114000, and the non-taxable bargain of 9500 would show up as an addition to the consolidated R/E.

 

[Griet van Vliet]

Now that it has been determined that there is no further adjustment necessary to the balance sheet, the consolidated financial statements can now be prepared (she found a little disappointing that there is no cash nor detail on the liabilities, but presumably they are accounts payable to her):

Oakridge​

Consolidated income statement​

EBIT 114600
Income tax expense 24880
Net income 89720

Oakridge​

Consolidated statement of changes in equity​

Beginning retained earnings 143280
Net income 89720
Ending retained earnings 233000

Oakridge​

Consolidated balance sheet​

Assets:

Land 20000
PP&E 666000
Inventory 38000

Total assets 724000

Liabilities and equity:

Liabilities 46000
Share capital 445000
Retained earnings 233000

Total liabilities and equity 724000