There are three views on allocating income taxes between periods: no allocation, partial allocation, and comprehensive allocation. Capital leases require lessees to recognize the leased asset and liability on their balance sheet, while operating leases do not require asset recognition and rent is expensed monthly. Direct financing leases and capital contracts require lessors to recognize the net investment in the lease as an asset and any differences between investment and costs as unearned income.

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Topic: Income Tax and Leases Type: CourseWork Subject: Accounting and Finance
Academic Level: Undergraduate Style: MLA Language: English (U.S)
Number of Pages: 3 (double-spaced, Times New Roman, Font 12)
Number of sources: 1
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Task Details
There are three general views regarding inter period income tax allocation: no allocation, partial
allocation, and comprehensive allocation. Required: a. Defend the position of no allocation of
income taxes. b. Defend the position of partial allocation of income taxes. c. Defend the position
of comprehensive allocation of income taxes.
Capital leases and operating leases are the two classifications of leases described in FASB
pronouncements from the standpoint of the lessee. Required:
a. Describe how a capital lease would be accounted for by the lessee both at the inception of the
lease and during the first year of the lease, assuming the lease transfers ownership of the property
to the lessee by the end of the lease.
b. Describe how an operating lease would be accounted for by the lessee both at the inception of
the lease and during the first year of the lease, assuming the lessee makes equal monthly
payments at the beginning of each month of the lease.
c. Describe Direct Financing and Capital Contracts

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Income Tax Allocation
THREE GENERAL VIEWS REGARDING INTER-PERIOD INCOME TAX ALLOCATION
No allocation of income taxes
There are a number of valid arguments for companies that might wish to remove income
allocation entirely at the time income has been earned (Sachse). Most of the firms believe it is
costly, complex, inconsistent and irrelevant with the conceptual framework. For this reason,
companies that practice effective and efficient methods of decreasing income taxes, for instance,
growing investment in the fixed assets and big portions of their capital liabilities might never
realize cash outflows. Besides, future cash flows are always reduced to their current values.
However, both the partial and the comprehensive allocation of income taxes do not use current
values. Despite these objections and concerns, it cannot be denied that avoiding the expected
future payments would go against conservatism.
Partial allocation of income taxes
According to Sachse’s findings, all the timing differences cannot be reversed and that
their tax effects cannot facilitate payment of deferred tax liability. For the advocates of the partial
allocation of income tax, deferred tax liabilities would only be the portion of the comprehensive
tax liability that was expected to result in the cash outflows (Sachse). Besides, this is not a
conservative approach since the company management is given a leeway to choose the liabilities
to recognize and those to avoid.

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Comprehensive allocation of income taxes
This method requires that income tax expenses declared in the accounting period be
affected by all transactions and be further included when calculating the pretax financial
accounting revenue for that particular fiscal year. Both the GAAP and IFRS require the
comprehensive allocation approach for the recognition of income taxes (Sachse). The matching
argument is used in the justification of detailed allocation on grounds that the principle requires a
full matching of revenue and expenses, hence the most conservative approach.
ACCOUNTING FOR A CAPITAL-LEASE BY THE LEASE
The capital lease shall be recognized as an obligation, but valued as the initial lease-
term’s minimum lease payment’s current value, but exclude executor expenses like maintenance,
insurance and profit paid by the lessor (Sachse). But in case the established amount exceeds the
initial leased asset’s fair value, it may imply that obligation and asset value be considered as the
fair value. Approximations in some situations are used, especially if an accurate value of the
executor and profit cannot be established. Assets recorded in the capital lease, and accumulated
amortization shall be identified differently in the lease’s statement of accounts or the footnotes
thereto.

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ACCOUNTING FOR AN OPERATING-LEASE BY THE LEASE
From Sachse’s findings, Rental operating lease is treated as an expense over the entire
lease period as the lease is paid on a monthly basis. Sachse’s argument is that rent should be
evenly charged through a leased property’s life, especially if it is not charged monthly. Also, rent
need to be fully settled by the end of the latest fiscal year for five succeeding years.
DIRECT FINANCING AND CAPITAL CONTRACTS
Sachse recommends the capital/sales-type leases to be accounted for as follows; the
lessor to settle in full executor expense and an approximate amount of the accumulated fair
value, before they can be entered in the lease agreement as monetary asset. However, the
difference from this investment and the accumulated amount of executor expense and fair value
should be recognized as income-not-earned, which should be then depreciated to obtain constant
percentage of monetary asset. The interest rate is implicit in the lease should be used to find the
discount rate, which would be used to lower the unearned income’s total investment.
According to Sachse’s analysis, direct financing leases need to be accounted for by the
lessor as follows; the leased payment that is net of the executor costs like taxes, insurance and
maintenance paid by Lessor together with the unguaranteed residual are part of the monetary
asset Differences in the lease and cost’s monetary asset should be recognized as income-not-
earned in the balance sheet. Capital expenditure should comprise of the monetary asset minus

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income-not earned. Any revenue not realized should be depreciated to obtain a constant
percentage of the monetary asset so that it can be recognized as an asset when classifying
noncurrent and current assets in the balance sheet. According to Sachse’s research, the contingent
rentals that include the rental based on the variable like the prime-interest rate shall be credited to
the income.

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Works Cited
Sachse, Willem. Accounting for leases. Munich: GRIN Verlag, 2006.
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