Crime Control Co. accounts for a substantial part of its alarm system sales under the sales-type (capitalized)
Question:
Crime Control Co. accounts for a substantial part of its alarm system sales under the sales-type (capitalized) lease method. Under this method the company computes the present value of the total receipts it expects to get (over periods as long as eight years) from a lease and records this present value amount as sales in the first year of the lease. Justification for this accounting is that the 8-year lease extends over more than 75% of the 10-year useful life of the equipment. While the sales-type lease method is used for financial reporting, for tax purposes the company reports revenues only when received. Because first-year expenses of a lease are particularly large, the company reports substantial tax losses on these leases.
Required:
a. Critics maintain the sales-type lease method “front loads” income and that reported earnings may not be received in cash for several years. Comment on this criticism.
b. Will financial reporting income be improved from the company’s tax benefit?
c. The company insistsit can achieve earnings result in similar to those achieved by the the sales-type lease method by selling the lease receivables to third-party lessors or financial institutions. Comment on this assertion
Exercise 6-9
An analyst must be familiar with the concepts involved in determining income. The amount of in- come reported for a company depends on the recognition of revenues and expenses for a given time period. In certain cases, costs are recognized as expenses at the time of product sale; in other situations, guidelines are applied in capitalizing costs and recognizing them as expenses in future periods.
Required: a. Explain the rationale for recognizing costs as expenses at the time of product sale.
b. What is the rationale underlying the appropriateness of treating costs as expenses of a period instead of assigning the costs to an asset? Explain.
c. Under what circumstances is it appropriate to treat a cost of a an asset instead of as an expense? Explain.
d. Certain expenses are assigned to specific accounting periods on the basis of systematic and rational allocation of asset cost. Explain the underlying rationale for recognizing expenses on this basis.
e. Identify the conditions necessary to treat a cost a loss.
Problem 6-3
Financial Statement Analysis
ISBN: 978-0078110962
11th edition
Authors: K. R. Subramanyam, John Wild