Question

Read the following case study:

The Whitley Corporation's year-end is December 31, 2013. It is now October 1, 2013. The Whitley management team is taking a look at the prior nine months and attempting to make some short-term strategy decisions.

Whitley has experienced steady growth over the five preceding years. The result has been a steadily increasing EPS. Last year, Whitley reported an EPS of 1.95.

This year, owing to a mild recession, Whitley's sales have fallen off. Management is looking for strategies that can improve the appearance of the financial statements. At the same time, there is a need for new equipment in the plant. Despite the recession, Whitley has enough cash to make the purchase.

Based on the year's performance to date and extrapolation of the results to year-end, management feels that the pretax financial accounting income for the year will be $200,000. Transactions from prior years have resulted in a deferred tax asset of $15,000 and a deferred tax liability of $70,000 at the beginning of 2013. The temporary difference of $37,500 that resulted in the deferred tax asset is expected to completely reverse by the end of 2013. The deferred tax liability resulted totally from temporary depreciation differences. There will be a pretax reversal of $42,500 in this temporary difference during 2013.

Based on currently enacted tax law, the purchase of the equipment will result in a future taxable amount of $50,000. Whitley management feels that it can wait four to six months to purchase the machine. Whitley's tax rate is 40 percent.

Write a response of 700 to 1,050 words to the following (Answer the a, b, c, & d below and I will write as a paper):

Determine the projected amount of income tax expense that would be reported if Whitley waits until next year to purchase the equipment.

Determine the projected amount of income tax expense that would be reported if Whitley purchases the equipment in 2013.

Explain why Whitley should/shouldn't wait to purchase the equipment. Your answer should take into consideration the expected financial statement effects, as well as the effect on EPS. Support your conclusions with pro forma data. The number of shares that Whitley will use to calculate EPS is 55,500.

Determine the ethical considerations of this case.

W4 Individual

Use the following template to complete and submit your week 4 homework assignment:

Please note the following from the publisher:

There is insufficient information to calculate the amount of depreciation that would be deducted from the $200,000 pretax accounting income if the purchase were made; hence, the solution will ignore it (do not discuss "make" option) and concentrate only on the deferred tax impacts.

a.       Use the following format to answer (a): The projected amount of income tax expense that would be recognized if Whitley waits until next year to purchase the equipment is calculated as follows:

Pretax accounting income                                               $200,000

Reversal of deductible amount

Reversal of taxable amount

Taxable income

Tax rate                                                                        x 40%

Taxes payable

Decrease in deferred tax asset

Decrease in deferred tax liability (42,500 x 40%)

Income tax expense                                                       $

b.         The projected amount of income tax expense that would be recognized if Whitley purchases the equipment in 2013 is calculated as follows:

Income tax expense, calculated in a.                               $

Increase in deferred tax liability (50,000 x 40%)

Income tax expense                                                       $

c.       EPS - Postpone purchase:                                              =

EPS - purchase in 2013:

Decline in EPS                                                               $

d. Determine the ethical considerations of this case.

Answer 1

1. The projected amount of income tax expense that would be recognized if Whitley waits until next year to purchase the equipment is calculated as follows:

Particulars	Amount in $	Amount in $
Pretax Profit	200,000
Less: Reversal of deductible amount	- 37,500
Reversal of Taxable amount	+ 42,500
Taxable Income		205,000
Tax payable on Above Income @ 40%	82,000
Add: Reversal of Deferred Tax Assets ($37,500 X 40%)	15,000
Less: Reversal of Deferred Tax Liability ($42,500 X 40%)	17,000
Total Tax Expenses		80,000
Profit after Tax		120,000
EPS		2.16

2.  Determine the projected amount of income tax expense that would be reported if Whitley purchases the equipment in 2013.

As per the Para of the Question New Equipment purchase will result in future taxable Income amount of $ 50,000. It will result into temporary difference which will be reverse in future year and future tax liability will increase hence, we have to create Differed tax Liability on this difference.

Particulars	Amount in $	Amount in $
Taxable Income of Answer 1		205,000
Tax payable on Above Income @ 40%	82,000
Add: Reversal of Deferred Tax Assets ($37,500 X 40%)	15,000
Add:Deferred Tax Liability [($50,000 - $42,500)X 40%]	3,000
Total Tax Expenses		100,000
Profit after Tax		100,000
EPS		1.80

3. The decision of the purchase of new equipment affect the following item of the Balance Sheet and Income Statement of the Company:

1. Decrease in Current Assets (Cash) balance due to payment of New asset and Increase in Capital Asset which affect Current ration of the Company
2. Increase in deferred tax Liability will increase long-term liabilities which affect debt to equity ratio of the Company
3. Depreciation would decrease Income of the Company
4. EPS (Without depreciation expense on new Equipment )  of the Company get effected as follow:

Particulars	EPS (If New Equipment not purchase)	EPS (if New Equipment purchase)	Decrease in EPS
EPS	2.16	1.80	0.36

Further The management of the company in a view to improve the appearance of financial statements of the company and new Equipment purchase will fall EPS of the Company below the EPS of Last year of $ 1.95. Hence, the Purchase of Equipment should be Postponed.

4.   The decision of postponement of Equipment will serve the purpose of management i.e improve the appearance of financial statements by increasing EPS. But, the decision is just a kind of window dressing and management will face consequences of this decision if 2014 is worse than 2013. The ethical considerations is that a company should not make economic decisions on financial statement appearance. It is just a picture of economic reality regardless of what that company’s needs.