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Lovely Professional UniversityLecture 1.

U.S. Accounting and Tax System

Howard Godfrey, Ph.D., CPAProfessor of Accounting

Copyright © 2010Edited June 24, 2010

Let me add my word of welcome to UNC Charlotte, Charlotte, and the U.S.

I hope you are enjoying your stay here and having a very productive learning experience.

I hope these two presentations will be valuable for you in understanding:

1. Our accounting and tax system, and

2. Results of some of our research on multi-national tax planning practices.

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After discussing some basic items, I will address two questions that were asked during your welcome reception a few weeks ago.

1.How do accounting principles in the U.S. compare to principles used in India?

2.How heavily are we taxed in this country (by federal government, state, county, and city)?

Assume, you moved to Charlotte to start a new business that sells products made by your family business in India.If you want to start a corporation here, what steps will you take? [Charter]Partnership? LLC? Suppose you buy U.S. property to be owned by your family business in India and the U.S. business is also owned by the family business in India. [Authority]

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India-in-Charlotte1 Invested cash 100,0002 Bought building 400,0003 Bought products 600,0004 Paid for products 550,0005 Sales at retail 1,000,0006 Collections 960,000

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India-in-Charlotte

7 Paid salaries 200,0008 Payroll taxes (FICA) 15,3009 Paid utilities 20,700

10 Cost of inventory sold 520,00011 Depreciation Expense 10,00012 Other Expenses 134,000

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"India-in-Charlotte"Transactions Amount

1 Invested cash in "India-in-Charlotte" 100,0002 Bought building on credit 400,0003 Bought products ($50,000 per mo.) 600,0004 Paid for 11 months of purchases 550,0005 Sales at retail 1,000,0006 Collections on sales 960,0007 Paid salaries 200,0008 Payroll taxes (7.65% FICA) 15,3009 Paid utilities 20,700

10 Cost of inventory sold 520,00011 Depreciation Expense 10,00012 Other Expenses 134,000

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Sales $1,000,000Salary Expense 200,000Payroll tax 15,300Utilities Expense 20,700Cost of sales 520,000Depreciation 10,000Other Expense 134,000Total Expenses 900,000Net Income before tax $100,000

Income Statement

Accounting Principles.Do you note the important accounting principles applicable to the accounts shaded in yellow on the preceding page?1. Sales (Sold $1,000,000, collected $960,000)

Ending receivables: $40,000. Collectible?

2. Cost of sales(Bought inventory for $600,000, sold inventory with a cost of $520,000. Ending inventory has a cost of $80,000)

3. Depreciation Expense. We assumed the building will have a useful life of 40 years when computing depreciation. Tax methods.

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Begin. BalanceAdd: Net IncomeLess: DividendsEnding Ret. Earn.

Retained EarningsIndia-in-Charlotte

Begin. Balance $0Add: Net Income 100,000Less: Dividends 0Ending Ret. Earn. $100,000

Retained EarningsIndia-in-Charlotte

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Cash $140,000Accounts Receivable 40,000Inventory 80,000 $260,000Building 400,000Accum. Depreciation (10,000) $390,000Total Assets $650,000Accounts Payable $50,000Mortgage 400,000 450,000Common Stock 100,000Retained Earnings 100,000Stockholder Equity 200,000Liabilities and Equity $650,000

Balance Sheet

How does the balance sheet shown on the preceding slide compare with the financial statements you are accustomed to preparing or analyzing in India?

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Do you compute a current ratio?

Capital structure?

Debt Ratio?

Comment on cash

flow in 2008.15

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Atul Ltd Headquartered in Atul,

Gujarat

• Present in China, Germany, the UK and the USA through subsidiary companies

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Atul Operating results: 2007-08Revenue 104,138Operating profit (PBIDT) 9,780Interest 3,079Gross profit 6,701Depreciation 2,955Taxation 267Net profit 3,479Dividends* 1,041Profit retained (a) 2,438

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Profit and Loss Account For the year ended 2007-2008INCOME:Sales and Operating Income 101,368Other Income 2,770

104,138EXPENDITURE:Cost of goods sold and materials consumed 58,152Manufacturing Expenditure 19,001Employees' Emoluments 7,574Interest and Finance charges (net) 3,079Others 9,485Depreciation & amortisation 2,955 100,245Profit before Tax & Exceptional / Non recurring items 3,893Exceptional / Non recurring items:Payment under VRS (478)Excess Provision for doubtful loans & advances written back331 (147)Profit before Taxation 3,745

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Atul Financial position: 2007-08Gross block 93,630 Net block 43,312 Net current & other assets 42,840 Capital employed 86,152 Equity share capital 2,967 Reserves and surplus 40,346 Shareholder's equity 43,313 Preference share -Borrowings 42,839

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I SOURCES OF FUNDS:1 Shareholders’ Fund:(a) Capital 2,967.48(b) Reserves and Surplus 40,345.23 43,312.712 Loan Funds:(a) Secured Loans 36,791.73(b) Unsecured Loans 6,047.35 42,839.083 Deferred Tax Liability (net) 1,610.89

87,762.68

Balance Sheet As at March 31, 2008Atul Ltd

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II APPLICATION OF FUNDS:1 Fixed Assets: (a) Gross Block 87,440.82(b) Less: Deprec & Impair. loss -50,318.00(c) Net Block 37,122.82(d) Capital work in prog. 2,508.64(e) Advances against cap. expend. 3,680.71 43,312.172 Investments: 6,512.91

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3 Current Assets, Loans & Advances:(a) Inventories 20,927.68(b) Sundry Debtors 28,111.07(c) Cash and Bank Balances 2,335.44(d) Other Current Assets 18.99(e) Loans and Advances 11,339.70

62,732.88Less: Current Liabilities & Provisions:(a) Liabilities 22,324.85(b) Provisions 2,470.43

24,795.28Net Current Assets 37,937.60

87,762.68

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Sales $1,000,000Salary Expense 200,000Payroll tax 15,300Utilities Expense 20,700Cost of sales 520,000Depreciation 10,000Other Expense 134,000Total Expenses 900,000Net Income before tax $100,000

Income Statement

Please compute income tax that your corporation will pay to the U.S. and to North Carolina, based on net income of $100,000.

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Tax. income $100,000Tax RateIncome Tax

N. C. Income Tax

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Tax. income $100,000Tax Rate 6.90%Income Tax $6,900

N. C. Income Tax

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Rate Base Tax15%25%34%

Total $100,000

Federal Income Tax

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Rate Base Tax15% $50,000 $7,50025% $25,000 $6,25034% $25,000 $8,500

Total $100,000 $22,250

Federal Income Tax

How much state franchise tax will be paid?

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Suppose you operate the business as a Limited Liability Company, or as a proprietorship.

How much income tax will be paid to NC & IRS?

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Suppose you receive a salary of $60,000 from the corporation and you are the only employee.

How much FICA is withheld?

How much FICA is paid to the IRS by the corporation?

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Salary $60,000Tax RateSoc.Sec. Tax

Social Secuity Tax

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Salary $60,000Tax Rate 7.65%Soc.Sec. Tax $6,900

Social Secuity Tax

What other taxes will the corporation pay?1.Sales taxes2.Unemployment taxes3.Property taxes4.Gasoline taxesMake a list and compute total taxes the corporation will pay.

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Now, lets look at the taxation of the U.S.Overall, each year the government collects (or borrows) over $10,000 for each person, although some is actually collected from businesses, etc.

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2010 budget of about $3.7 trillion for a country of about 310 million people.

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Federal ($billions)-2009Individual income tax $915Corporate income tax 138Social Security Tax 654Medicare 191Other ??Total 2,105Also borrowing!!!!! 1,413

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North Carolina ($millions)

Income tax

(Indiv & Corp) $11,184

Sales tax 5,038

Other 2,353

Total 18,57638

Meck. County ($millions)Property tax - Current $819Property tax – Prior 17Sales Tax 132Other 10Investment income 7Total $986Population

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City of Charlotte - Total FY2010 Budget

• $1.87 billion

– Operating Budget

$1.06 billion

– Capital Budget $803.9 million

Charlotte Percent

Property tax 63.5%

Sales Tax 12.9%

Fees 10.9%

Etc.

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Currency Issues

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In a global economy, with transactions across borders, it is necessary to deal with currency issues. The next few slides deal with ATUL, Ltd. located in the Charlotte area that is owned by a company in India.

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ATUL indicates in its annual report that it has been hurt by the declining dollar and it translates financial statements of subsidiaries in 4 other countries into rupee.

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Lets use the next few slides to discuss some global finance issues related to currency.

We will also look at the policies used by HP and IBM when translating financial statements that have been prepared in foreign currencies.

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Atul Annual ReportIn a challenging business

environment in 2007-08…

• The US dollar depreciated around 12% against the Indian rupee

• What does that mean? See example of transaction on next 2 slides (with exchange rates changing).

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Atul- Accounting Policies

7 Foreign Currency Transaction:

7.1 Initial Recognition:

Transactions denominated in foreign currencies are recorded at the rate prevailing on the date of the transaction.

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Atul- Accounting Policies7 Foreign Currency Transaction:7.2 Conversion:At the year-end, monetary items denominated in foreign currencies ..are converted into rupee equivalents at the year-end exchange rates. Non monetary items which are carried at historical cost denominated in a foreign currency are reported using the exchange rate at date of transaction.

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Atul- Accounting Policies7 Foreign Currency Transaction:7.3 Exchange Differences:All exchange differences arising on settlement and conversion of foreign currency transactions are included in the profit & loss account, except where they relate to the acquisition of fixed assets, acquired out of India in which case they are adjusted in the cost of the corresponding asset.

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Impact of Exchange Rates on Income

1.On 6-1-09, a U.S. corp. sold its product to a Hong Kong co. for $400,000HKD,

2.On 6-1-09, exchange rate was $8HKD to $1USD.

3.Hong Kong co. will pay later in Hong Kong currency.

4.Later when U.S. corp. receives payment, exchange rate is $10HKD to $1USD.

5.What is the gain or loss for the U.S. corp. as a result of these transactions?

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Atul, ContinuedTrans $HK $U.S.

Sale $8 $HK $400,000 $50,000

Collect $10 $HK $400,000 $40,000

Loss $10,000 Currency Loss - weakening of HK dollarThese exchanges rates are hypothetical.

Exchange

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Atul LtdPresent in China, Germany,

the UK and the USA through subsidiary companies.

Atul must translate financial statements in 4 other currencies to the Indian rupee

The next slide has financial statements for a hypothetical company.

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Parent bought Sub when $1FCD = $.25 USD. (U.S. Dollar)Foreign Currency Dollar ($FCD) is devalued to $1 FCD = $.20 USD.

FCD USDAssets FCD=$.25 US Dollar

Cash $1,000 $250 $0.20 $200Accounts Receivable 2,000 500 $0.20 400Inventory 1,000 250 $0.20 200Fixed Assets 4,000 1,000 $0.20 800

Total Assets $8,000 $2,000 $1,600LiabilitiesAccounts Payable $1,000 $250 $0.20 $200Long-Term Debt 1,000 250 $0.20 200Owner Equity 6,000 1,500 $0.25 1,500Translation Gain (Loss) ($300)Adjusted Equity $1,200

Debt plus Equity $8,000 $2,000 $1,600

At AcquisitionCurrent Rate

FCD is Devalued

Parent bought Sub when $1FCD = $.25 USD. (U.S. Dollar)Now $1 FCD = $.20 USD.

FCD USDAssets FCD=$.25 US Dol

Cash $1,000 $250 $0.20 $200

Accts Rec. 2,000 500 $0.20 400

Inventory 1,000 250 $0.20 200

Fixed Assets 4,000 1,000 $0.20 800

Total $8,000 $2,000 $1,600

At AcquisitionCurrent Rate

FCD is Devalued

Parent bought Sub when $1FCD = $.25 USD. (U.S. Dollar)Now - $1 FCD = $.20 USD.

FCD USDLiabilities FCD=$.25 US Dol

Accts Payable $1,000 $250 $0.20 $200

Long-Term Debt 1,000 250 $0.20 200

Owner Equity 6,000 1,500 $0.25 1,500

Tran. Gain (Loss) ($300)

Adjusted Equity $1,200

Debt + Equity $8,000 $2,000 $1,600

At AcquisitionCurrent Rate

FCD is Devalued

IBM. 2008 Annual Report. Translation of Non-U.S. currency amounts reported bySubsidiaries.Assets and liabilities of non-U.S. subsidiaries that have a local functional currency are translated to U.S. dollars at year-end exchange rates. Translation adjustments are recorded in accumulated gains and (losses) not affecting retained earnings in the Consolidated Statement of Stockholders’ Equity. Income and expense items are translated at weighted-average rates of exchange prevailing during the year.

HP-We are exposed to foreign currency exchange rate risk inherent in our sales commitments, anticipated sales, anticipated purchases and assets, liabilities and debt denominated in currencies other than the U.S. dollar. We transact business in approximately 40 currencies worldwide, of which the most significant to our operations for fiscal 2008 were the euro, the Japanese yen and the British pound.

(HP) Dear Fellow Stockholders,Fiscal 2008 was a strong year with some notable accomplishments. …Fiscal 2008 was also a difficult year... HP proved our ability to execute in a tough environment.In 2008, HP delivered:• Net revenue growth of 13 percent, or 8 percent in constant currency, to $118.4 billion

Foreign Currency TransactionsHP uses U.S. dollar predominately as functional currency. Assets and liabilities denominated in non-U.S. dollars are remeasured into U.S. dollars

1. at current exchange rates for monetary assets and liabilities, and

2. historical exchange rates for nonmonetary assets and liabilities.

Net revenue, cost of sales and expenses are remeasured at average exchange rates in effect during each period, except for those net revenue, cost of sales and expenses related to the previously noted balance sheet amounts, which HP remeasures at historical exchange rates.

HP includes gains or losses from foreign currency remeasurement in net earnings.

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Summary-Impact of changes in exchange rates.If you use different exchange rates for different accounts on the balance sheet, you put the report out of balance.How you view the subsidiary (extension of parent, or a very separate company) determines how you translate foreign statements.

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Atul Ltd – Annual ReportThe net exchange difference

resulting from the translation of items in financial statement of the subsidiaries is recognised as income or expense under the head "Exchange difference on translation of foreign subsidiaries."

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The

End