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Chapter 6: Question 19Q (page 301)

Property/casualty insurance companies have been criticized because they reserve for the total loss as much as 5 years before it may happen. The IRS has joined the debate because it says the full reserve is unfair from a taxation viewpoint. What do you believe is the IRS position?

Short Answer

Expert verified

The IRS believes that reserves should be discounted on present value, which will lead to an increase in income and, therefore, in income taxes.

Step by step solution

01

Definition of IRS

The IRS stands for Internal Revenue Service, a federal agency of the US government responsible for collecting the taxes and enforcing tax laws.

02

Position of IRS

The IRS argues that the future reserves must be discounted to the present value. This will lead to smaller reserves, so they charge less of income. This will result in higher income and higher income taxes as well.

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Most popular questions from this chapter

Question: Kehoe, Inc. owes $40,000 to Ritter Company. How much would Kehoe have to pay each year if the debt is retired through four equal payments (made at the end of the year), given an interest rate on the debt of 12%? (Round to two decimal places.)

Henry Quincy wants to withdraw $30,000 each year for 10 years from a fund that earns 8% interest. How much must he invest today if the first withdrawal is at year-end? How much must he invest today if the first withdrawal takes place immediately?

Dunn Inc. owns and operates a number of hardware stores in the New England region. Recently, the company has decided to locate another store in a rapidly growing area of Maryland. The company is trying to decide whether to purchase or lease the building and related facilities.

Purchase: The company can purchase the site, construct the building, and purchase all store fi xtures. The cost would be \(1,850,000. An immediate down payment of \)400,000 is required, and the remaining \(1,450,000 would be paid off over 5 years at \)350,000 per year (including interest payments made at end of year). The property is expected to have a useful life of 12 years, and then it will be sold for \(500,000. As the owner of the property, the company will have the following outof-pocket expenses each period.

Property taxes (to be paid at the end of each year) \)40,000

Insurance (to be paid at the beginning of each year) 27,000

Other (primarily maintenance which occurs at the end of each year) 16,000

\(83,000

Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate fi xtures for Dunn Inc. if Dunn will lease the completed facility for 12 years. The annual costs for the lease would be \)270,000. Dunn would have no responsibility related to the facility over the 12 years. The terms of the lease are that Dunn would be required to make 12 annual payments (the fi rst payment to be made at the time the store opens and then each following year). In addition, a deposit of $100,000 is required when the store is opened. This deposit will be returned at the end of the twelfth year, assuming no unusual damage to the building structure or fixtures.

Instructions Which of the two approaches should Dunn Inc. follow? (Currently, the cost of funds for Dunn Inc. is 10%.)

Adams Inc. will deposit $30,000 in a 6% fund at the end of each year for 8 years beginning December 31, 2017. What amount will be in the fund immediately after the last deposit?

Question: What is the time value of money? Why should accountants have an understanding of compound interest, annuities, and present value concepts?
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