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Part I

Leases

To: Conner and Martin Subject: Lease agreement with Tyler Leasing Company Below is the list of advantages of leasing versus owning equipment: 1. 100% financing at fixed rates: Lease are often signed without requiring any money down from the lessee, helping to conserve scarce cash. In addition, lease payments often remain fixed which protects the lessee against inflation and increases in the cost of money. 2. Protection against obsolescence: Leasing equipment reduces the risk of obsolescence to the lessee, and in many cases passes the risk of residual value to the lessor. 3. Flexibility: Lease agreements may contain less restrictive provisions than other debt agreements. 4. Less costly financing for Lessee: Some companies find leasing cheaper than other forms of financing. 5. Off-Balance sheet financing: Certain leases do not add debt on a balance sheet or affect financial ratios, and may add to borrowing capacity. Off- balance sheet financing has been critical to some companies. With regards to the current lease option with Tyler Leasing Company, here is the calculation for classifying the lease agreement as capital or operating lease. Present value of 5 annual rental payments of $145,661 Begin Mode pva$145661, 5n, 10iy, 0fv, compute present value = Add: Present value of guaranteed residual value of $125,000 Fv $125000, 5n, 10iy, 0pmt, compute present value = Capitalized amount = ($685000 or using PV computations $685002) $77,615 $685,002 $607,387

The lease meets the criteria for classification as a capital lease under both IFRS and private enterprise standards for the following reasons: Under PE GAAP: y y The 75% threshold in the PE standard is met The present value of the minimum lease payments and the present value of the residual value is $685,000 and this is the same as the assets fair value. Therefore it exceeds the 90% of fair value threshold set out in the PE standard

Only one of the capitalization criteria has to be met to justify classification as a Capital lease.

Under IFRS: y Under IFRS the requirement is that the lease allows the lessor to recover substantially all of its investment in the leased property and earn a return on the investment. This is provided if the minimum value of the lease payments is close to the fair value of the asset. Since the present value of the minimum lease payments and the present value of the residual value is $685,000 and this is the same as the assets fair value, the requirement is met.

The effect of the proposal on the companys balance sheet in 2010:

Current Liabilities Interest Payable Obligations under capital leases Noncurrent liabilities Obligation under capital leases Property, Plant and equipment: Equipment under capital Lease Less: Accumulated depreciation $685,000 85,625 $599,375 $447,612.00 $53,933.90 91,727.10

If the lease was an operating lease than the debt-to-equity ratio would have been higher. The asset would not have been recorded on the balance sheet. The change to the income statement for rent expense each year is $145,661, the amount of the rental payment. The reason why Tyler would want a guaranteed residual value is because the value is going to be realized and would safeguard some return on the asset. As the risk of non-recovery is reduced, the lessor may reduce the required rate of return and therefore the rental payment required.

Part II- Income tax

To: Conner and Martin Subject: Concepts of Permanent and Temporary Differences Permanent differences are caused by items that: (1) are included in accounting income but never in taxable income or, (2) are included in taxable income but never in accounting income Two types: y Items that is included in accounting income but never in taxable income: non tax-deductible expenses such as fines and penalties, golf and social club dues, and expenses related to the earning of non- taxable revenue, and non-taxable revenue such as dividends from taxable Canadian Corporations and proceeds on life insurance policies carried by the company on key officers or employees. Items that are included in taxable income but never in accounting income: depletion allowances of natural resources that exceed the resources cost.

Since permanent differences affect only the period in which they occur, there are no deferred or future tax consequences associated with the related balance sheet accounts. Temporary differences are the differences between the tax basis of an asset or liability and its reported amount in the balance sheet. Two types: y A taxable temporary difference will result in taxable amounts in future years when the carrying amount of the asset is received or the liability is settled. That is, the effect is an increase in taxable income and income taxes in the future. (2) A deductible temporary difference will decrease taxable income and taxes in the future. Example account receivables realized in future years and warranty liability payable in future years.

Hope this will give clarity on the concepts of permanent and temporary differences.

To: Conner and Martin Subject: Adjusting entries to calculate income tax On reviewing the various adjusting entries made during the year 2010 the following effects are noticeable on the income tax expense. Accounting income before income taxes Add: Non -deductible life insurance premium 80,000 Income from investment Warranty expense 7,000 75,000 $162,000 $672,000 Less: Depreciation excess Taxable income before income taxes Income tax expense payable for 2010 (35% x 642,000) $30,000 $642,000 $224,700 $510,000

Thus, the income tax expense will increase $46200. From $178,500 to $ 224,700 for the year 2010 due to the above mentioned temporary and permanent differences.

Additional activities: a) To: Conner and Martin Subject: Classification of deferred tax assets and liabilities The classification of an individual deferred or future tax asset or liability as current and non-current is determined by the classification of the asset or liability underlying the specific temporary difference. Here are the steps:

Step1: What is the classification of the asset or liability that resulted in the asset or liability? If it is caused by a temporary difference in an asset or liability classified as noncurrent it is identified as noncurrent. A tax asset or tax liability caused by a temporary difference in a current asset or liability account is classified as current. If there is no related asset or liability on the balance sheet, such as with tax loss, the future tax account is classified according to the expected reversal date of the temporary difference: if it is within 12 months from the reporting date, it is current; otherwise, it Is noncurrent. Step 2: Determine the net current amount. IF by netting the various future tax asset and liability amounts that are classified as current, the net result is an asset, report it on the balance sheet as current asset. If it is a liability, report it as current liability. Step 3: Determine the net noncurrent amount. Net the various future tax assets and liabilities that are classified as noncurrent. If the net result in an asset, report it on the balance sheet as a noncurrent asset. If it is a liability, report it as a long term liability. b) To: Conner and Martin Subject: Treating Deferred Tax Asset Both private enterprise and international standards recommend recognizing a deferred income tax asset for most deductible differences, to the extent that it is probable that the future income tax asset will be realized. The accounting standards offer guidance on how to determine whether it is probable that the deferred taxable income of an appropriate nature, and relating to the same taxable entity and the same tax authority, will be available. The following possible sources of taxable income may be available under the tax law to realize a tax benefit: 1. Future reversals of existing taxable temporary differences 2. Future or deferred taxable income before taking into account reversing temporary differences, tax loss and other tax reductions 3. Taxable income available in prior carry back years 4. Tax planning strategies that would if necessary be implemented to realize future or deferred tax asset Both favourable and unfavourable evidence is considered with more weight attached to objectively verifiable evidence. The deferred tax asset account is also reviewed to determine whether conditions have changed, because it may now be reasonable to recognize future tax asset that was previously unrecognized. If conditions have changed the associated benefit is recognized in the income statement of the same period. Hope this will give you an insight as to how to treat the deferred tax asset. Please revert back to me if you have any questions.