PCMA 412 Midterm Exam Answers PDF

MIDTERM EXAMINATION 𝟖𝟓 PCMA 412 STRATEGIC TAX MANAGEMENT NAME:_____________________________________________________SECTION: ________ (Last Name) ( First...

MIDTERM EXAMINATION 𝟖𝟓 PCMA 412 STRATEGIC TAX MANAGEMENT NAME:_____________________________________________________SECTION: ________ (Last Name) ( First Name) ( Middle Initial) TEST I. TRUE OR FALSE. (25 items) Instruction: In the blank provided before each number, write TRUE if the statement is correct and FALSE if otherwise. TRUE 1. Tax avoidance is the legal usage of the tax regime to one's own advantage, to reduce the amount of tax that is payable by means that are within the law. FALSE 2. Tax Evasion implies the use of benefits of the law. TRUE 3. Tax Management aims to comply with legal formalities. FALSE 4. Mr. Alcantara claims personal expenses as business expenses. This is an example of tax avoidance. TRUE 5. Tax Planning involves planning one’s income in a legal manner to avail various exemptions and deductions. TRUE 6. Keeping two sets of books and making false entries in books and records is an example of Tax Evasion. TRUE 7. Mr. A invests in Public Provident Fund so as to reduce tax payable is an example of Tax Planning. FALSE 8. X Ltd installed an air conditioner at the residence of a director as per terms of his appointment; but treats it as fitted in quality control section in the factory. This is with the objective to treat it as plant for the purpose of computing depreciation. This is an example of Tax Avoidance. TRUE 9. Every businessman or a professional must maintain books of accounts and other relevant documents so that the tax can be computed accurately and verified by the Assessing Officer. TRUE 10. In the Philippine setting, the provisions of the Local Government Code (LGC) are not self-executing. FALSE 11. National Taxes refer to National Internal Revenue Taxes which may be collected by the local government. FALSE 12. Real Property Tax are among those taxes collected by the Bureau of Internal Revenue (BIR). TRUE 13. For financial reporting purposes, net losses cannot be carried forward (or backward) from prior (or future) years. FALSE 14. For tax purposes, net losses cannot be carried forward from prior years. 1|P age PCMA 412|Midterm Examination TRUE 15. The value added through internal financing is potentially higher than from external financing. FALSE 16. High Debt-Equity Ratio will grant a firm with a high credit ranking which will usually result in lower costs of acquiring additional external financing. TRUE 17. Offering performance-based bonuses to executives can align their interests with those of shareholders and improve company performance. FALSE 18. Relying solely on external financing means a new venture will have no impact on its equity structure and ownership distribution. FALSE 19. All forms of external financing, such as loans and equity investments, come with the same level of risk for the entrepreneur. TRUE 20. Research and development (R&D) expenses for new products can often be deducted from taxable income, providing tax incentives for companies to innovate. FALSE 21. A company that plans to improve its return on equity (ROE) only by increasing its financial leverage will not incur any impact on its risk of insolvency during economic downturns. FALSE 22. A company that issues convertible bonds will always face a dilution of earnings per share (EPS) if the bonds are converted into equity, regardless of its current earnings performance. TRUE 23. A company decides to finance its new project entirely with debt to take advantage of tax deductions on interest payments. If the project's returns exceed the cost of debt, the company can improve its overall profitability, but it also increases its financial risk profile. TRUE 24. A value-added tax (VAT) is a consumption tax that is levied at each stage of production and distribution, and businesses can usually reclaim the VAT they have paid on their purchases, reducing their overall tax burden. FALSE 25. A company investing in research and development (R&D) for a new product must capitalize its R&D expenses and amortize them over several years, rather than deducting the full amount from taxable income in the year the expenses are incurred. TEST II. MULTIPLE CHOICE (20 items) Instruction: In the blank provided before each number, write the letter that corresponds to your answer to each question. _______ 1. This is a type of tax imposed by the U.S. government when a person transfers property to another due to nonbusiness motives, such as affection and appreciation. a. Income Tax b. Gift Tax c. State and Local Tax d. Capital Gains Tax 2|P age PCMA 412|Midterm Examination _______ 2. Capital losses in the US setting. For financial purposes, losses on sales of assets are expensed as they are incurred. For tax purposes, losses on sales or other dispositions of capital assets can be deducted only to the extent of current year capital gains. If losses exceed gains, the excess losses are carried back three years and forward five years. Which of the following statement is FALSE? a. A corporation with a capital gain of $1 million will be taxed depending on the taxpayer's tax bracket for that year. b. A corporation with a capital loss of $ 1 million must be carried back three years and, if still unused, forward five years. c. A corporation that has two capital transactions for the year: a capital gain of $1 million and a capital loss of $1.5 million. The two are netted together, to give a net capital loss of $500,000. The loss may be carried back three years or forward five years. d. A corporation that has two capital transactions for the year: a capital gain of $1 million and a capital loss of $1.5 million. The two are netted together, to give a net capital loss of $500,000. The loss must be carried back three years and, if still unused, forward five years. _______ 3. Y and Z corporations each have sales revenues of $500,000. Expenses for the two corporations are $100,000 and $300,000, respectively. Corporation Y will pay more taxes, because it has greater net income and cash flows, and thus can afford to pay more. This case is under what Principle or Concept of Taxation? a. Entity Principle b. Pay-as-You-Go Concept c. All-Inclusive Income Principle d. Ability-to-Pay Principle _______ 4. An entrepreneur forms a corporation that develops and sells the entrepreneur’s software products. During the year, the corporation has $200,000 in revenue and $50,000 in expenses. The entrepreneur also has a salary of $100,000. The corporation will file a corporate tax return showing $50,000 in taxable income, and the entrepreneur will file an individual tax return showing $100,000 of income. This case is under what Principle or Concept of Taxation? a. Entity Principle b. Pay-as-You-Go Concept c. All-Inclusive Income Principle d. Ability-to-Pay Principle _______ 5. Toward the end of the year, engineers from the production department of Samsung Electronics would like to replace an old machinery with new machinery. Tax rates are scheduled to increase in the next year. What appropriate course of action should the management undertake to maximize the tax advantages of the transaction? a. Not to acquire the new machinery b. Acquire the machinery in the current year c. Acquire the machinery towards the end of next year 3|P age PCMA 412|Midterm Examination  d. Acquire the machinery early in the next year _______ 6. What SAVANT Principle is applied by the management with reference to the preceding question no. 5? a. Strategy b. Anticipation c. Negotiating d. Transforming _______ 7. A software company has excess cash and is considering acquiring a firm. Two targets appear attractive. One is a restaurant business holding company, which has historically earned a 15% return on investment and also has $100 million of tax benefits, which could be used by an acquiring firm. The other is a computer software firm with equal returns, but no tax advantages. Although the discounted cash flows appear higher for the restaurant business, despite the lack of tax advantage, the management still qualifies the acquisition of the computer software a better choice. What SAVANT Principle is applied by the management in the case? a. Strategy b. Anticipation c. Negotiating d. Transforming _______ 8. A management consulting firm owns a building in eventual need of a new roof. Instead of reroofing, the firm repairs a part each year because repairs are tax deductible, whereas a new roof must be capitalized. What SAVANT Principle is applied by the management in the case? a. Strategy b. Anticipation c. Negotiating d. Transforming _______ 9. A small entertainment firm wants to hire a talented manager away from a larger firm. The manager is currently being paid $10 million annually in salary, which is $2 million more than the small firm can afford. The small firm offers $5 million in cash and $5 million in stock options. Because the options are tax-favored, the manager may find the options very attractive. What SAVANT Principle is applied by the management in the case? a. Strategy b. Anticipation c. Negotiating d. Transforming _______ 10. This is considered as the ultimate aim of the SAVANT Principle. 4|P age PCMA 412|Midterm Examination  a. Reduce Tax Liability b. Increase current year profit c. Declare corporate dividends d. Maximize shareholders’ value _______ 11. It is the ability of firms to pass on the burden of a tax is known in economics as ________. a. Tax Shifting b. Bargaining c. Tax breaking d. Compromise _______ 12. It is the type of financing strategy applied by companies that limit expansion by purchasing new property, plant, and equipment only out of cash flows from operations. a. External Financing Strategy b. Internal Financing Strategy c. Debt Financing Strategy d. Equity Financing Strategy _______ 13. Which statement is FALSE in Financing? a. Debt financing requires periodic payment of interest. b. Internal financing is subject to payout and control restrictions compared to external financing. c. Equity financing will dilute earnings per share as well as control. d. Internal financing is easier to avail and timing can be easily controlled compared to external financing. _______ 14. Corporation A anticipated that the income tax rate will increase in the next year. Would it affect the corporations’ planned internal financing decisions in the current year? Choose the best answer. a. No, the current year’s financing decisions are not influenced by the anticipated tax increase in the succeeding year. b. No, regardless of the amount of fund requirement, Corporation A should still choose internal financing. c. Yes, the company must retain sufficient earnings to cover the expected increase in income payments. d. Yes, the increase in income tax will affect interest rates derived from internal financing. _______ 15. Under the following situations a firm is best to consider Internal Financing, except: a. Anticipated tax decrease b. High interest on debts c. Firm expects to be in a high tax bracket d. Profit margin is high 5|P age PCMA 412|Midterm Examination _______ 16. A startup is considering applying for a loan to finance its expansion. The owner is concerned about the tax implications of taking on debt. Which of the following statements best addresses the owner's concern? a. Interest payments on the loan are tax-deductible, which can lower the overall tax burden. b. Loans do not have any tax implications and do not need to be reported. c. Taking a loan will automatically increase taxable income. d. Debt financing is always more expensive than equity financing due to taxes. _______ 17. A new venture has invested heavily in research and development (R&D) for its innovative product. The CEO is reviewing the potential tax benefits. What is the most advantageous tax strategy for the venture? a. Ignore R&D tax credits, as they are not significant enough to affect cash flow. b. Claim the R&D tax credit to offset future taxable income, enhancing cash flow. c. Delay claiming R&D expenses to maximize tax liabilities in future years. d. Focus solely on advertising expenses, as they have better tax benefits than R&D. _______ 18. An employee is considering participating in a company-sponsored stock option plan. What is an important tax implication the employee should be aware of? a. Stock options are always taxed as ordinary income when granted. b. Employees can defer taxes until they exercise their options or sell the shares. c. There are no tax implications associated with stock options. d. All stock options are taxed at a flat rate, regardless of the holding period. _______ 19. A mid-sized company is expanding its workforce and considering various compensation structures to attract high-caliber talent. The HR director is weighing the pros and cons of offering a higher base salary versus additional non-cash benefits. Which scenario presents a potential disadvantage of choosing a higher base salary? a. Employees may perceive non-cash benefits as less valuable than cash compensation. b. A higher salary can lead to increased employee turnover if market conditions change. c. Non-cash benefits often require more administrative effort to manage. d. Increased payroll taxes for the company and reduced take-home pay for employees due to higher income tax liabilities. _______ 20. A company is planning to implement an employee stock purchase plan (ESPP) as part of its benefits package. The CFO is concerned about the tax implications for both the company and its employees. Which of the following points should the CFO prioritize when discussing the plan with stakeholders? a. Employees must pay taxes on the purchase price of the stock at the time of purchase. 6|P age PCMA 412|Midterm Examination  b. The ESPP will lead to immediate tax liabilities for the company, making it less attractive. c. Employees can only participate in the ESPP if they are in a high tax bracket. d. The company can potentially benefit from tax deductions based on employee purchases. TEST III: IDENTIFICATION & ENUMERATION. (10 items) Instruction: In the blank provided before each number, write the word described or defined by each statement. ____P500.00__1. Amount of Basic Community Tax paid by a Corporation where its principal office is located within the Philippines. _P90,000.00__2. The passing of the RA 10963 or the TRAIN Law increased the amount of tax- exempt benefits ceiling (13th-month pay and other benefits) from P82,000.00 to P __________. _____6%____ 3. Gifts with value exceeding P250,000.00 shall be taxed to a single rate of ________. Compensation 4. Is a systematic approach to providing monetary value to employees in exchange to work performed. ____________ 5. Give two (2) Mandatory Benefits granted to employees in the ____________ 6. Philippines in accordance to applicable laws and regulations. Power to Select and Hire7. Power to Pay Wages 8. What are the four (4) elements of an Employer-employee Relationship? Power to Dismiss 9. Power to Control 10. TEST IV: PRACTICAL EXAMINATION. (30 points) Instruction: Write your answer in the blank provided before each number. No need to show your solution. Problem 1: Interest Expense Deduction A startup is considering taking out a loan of $500,000 at an interest rate of 8% per year to finance its operations. Calculate the annual interest expense, and determine how much is the impact of the interest expense to the corporate income if the corporate tax rate is 30%. Questions: ____________ 1. What is the annual interest expense? $ 40,000.00 7|P age PCMA 412|Midterm Examination ____________ 2. How much is the impact of the interest expense to the corporate income? $12,000.00 Problem 2: R&D Tax Credit Calculation A tech company spends $200,000 on qualified research and development (R&D) activities. The company is eligible for a tax credit of 20% on its R&D expenses. Additionally, the company incurs $50,000 in regular operational expenses related to the R&D project. Calculate the total tax credit the company can claim and the impact on its taxable income if the corporate tax rate is 25%. Questions: ____________ 1. What is the total tax credit from R&D expenses? $40,000.00 ____________ 2. By how much will the operational expenses affect the taxable income? $12,500.00 Problem 3: Equity Financing and Dilution A startup raises $1 million by issuing new equity at a pre-money valuation of $4 million. After the investment, calculate the post-money valuation and the percentage of ownership dilution for existing shareholders. Additionally, if the startup expects to generate $1.5 million in taxable income, how would this affect the tax liability at a corporate tax rate of 21%? Questions: ____________ 1. What is the post-money valuation? $5,000,000.00 ____________ 2. What is the percentage of ownership dilution for existing shareholders? 20% ____________ 3. What will be the tax liability based on the expected taxable income? $ 315,000.00 Problem 4: Depreciation and Tax Shield A company invests $300,000 in new equipment for its manufacturing operations. The equipment has a useful life of 5 years and will be depreciated using the straight-line method. The company is subject to a corporate tax rate of 25%. Questions: ____________ 1. What is the annual depreciation expense? $60,000.00 ____________ 2. How much will the tax shield from the depreciation expense be each year? $15,000.00 ____________ 3. What is the total tax shield over the 5 years? $75,000.00 Problem 5: Employee Stock Option 8|P age PCMA 412|Midterm Examination A company grants an employee stock options for 1,500 shares at an exercise price of $40 per share. The options vest in 3 years and have a term of 7 years. At the end of the vesting period, the fair market value of the stock is $75 per share. The employee exercises the options 2 years after they vest when the fair market value is $85 per share. The employee then sells the shares for $95 per share after holding them for one year. Questions: ____________ 1. Intrinsic Value at Vesting: What is the intrinsic value of the stock options at the time of vesting? $52,500.00 ____________ 2. Ordinary Income on Exercise: What will be the ordinary income recognized by the employee when exercising the options at a fair market value of $85 per share? $67,500.00 ____________ 3. Total Cost to Exercise: What is the total cost to the employee to exercise the stock options? $60,000.00 ____________ 4. Capital Gains Calculation: What is the capital gain when the employee sells the shares for $95 per share after exercising them? $15,000.00 ____________ 5. Capital Gains Tax Liability: If the employee is in the 20% capital gains tax bracket, what will be the capital gains tax liability from the sale of the shares? $3,000.00 Problem 6: Pension Contribution Taxation An employee in the Philippines earns a monthly salary of PHP 60,000. The company provides a pension plan where both the employer and employee contribute to the plan. The employee contributes 5% of their salary to the pension fund, and the employer contributes 10%. In addition to the regular contributions, the employee also has a prior years’ service contribution that amounts to PHP 2,000 per month, which the company also matches with an employer contribution of PHP 2,000. According to Philippine tax regulations, the maximum deductible pension contribution is PHP 1,200 per month for the employee, and employer contributions are generally not subject to income tax. Questions: ____________ 1. Current Year Employee Contribution: Calculate the total amount contributed by the employee to the pension fund for the current year (excluding prior years’ service). Php36,000.00 ____________ 2. Current Year Employer Contribution: Calculate the total amount contributed by the employer to the pension fund for the current year (excluding prior years’ service). Php72,000.00 9|P age PCMA 412|Midterm Examination ____________ 3. Prior Years' Service Employee Contribution: Calculate the total amount contributed by the employee to the pension fund for prior years’ service. Php24,000.00 ____________ 4. Total Annual Contributions: Calculate the total annual contributions (employee + employer) to the pension fund for both current year service and prior years' service. Php156,000.00 ____________ 5. Tax Implications: If the employee's annual salary is PHP 720,000, what is the impact of the pension contributions on their taxable income? Php14,400.00 Problem 7: Investment Decision Between New Machinery and New Product Development A manufacturing company is evaluating two investment options: Option A: New Machinery Cost of Machinery: PHP 1,200,000 Useful Life: 5 years Annual Revenue Generated: PHP 900,000 Annual Operating Expenses: PHP 350,000 Salvage Value: PHP 100,000 Option B: New Product Development R&D Expenses: PHP 500,000 (one-time cost) Expected Annual Revenue from New Product: PHP 750,000 (starting from Year 1) Annual Operating Expenses: PHP 300,000 Useful Life: 4 years Tax Implications: Corporate Tax Rate: 30% The machinery will use straight-line depreciation for tax purposes. Questions: ____________ 1. Annual Depreciation Expense for Option A: Calculate the annual depreciation expense for the new machinery. P 220,000.00 ____________ 2. Annual Net Income Before Tax for Option A: Determine the annual net income before tax from the new machinery investment. P 330,000.00 ____________ 3. Annual Net Income Before Tax for Option B: Determine the annual net income before tax from the new product development. P 50,000.00 loss ____________ 4. Tax Liability for Both Options: Calculate the tax liability based on the annual net income before tax for both options. (Option A: No. ____________ 5. 4 & Option B: No. 5) Php99,000.00 & Php15,000.00 (MCIT) 10 | P a g e PCMA 412|Midterm Examination ____________ 6. Net Income After Tax for Both Options: Determine the net income after tax for both options. (Option A: No. 6 & Option B: No. ____________ 7. 7) P231,000.00 & P65,000.00 loss ____________ 8. Cash Flow Impact for Both Options: Determine the cash flow impact for both options in Year 1, including initial investments? ____________ 9. (Option A: No. 8 & Option B: No. 9) P749,000 out & P65,000.00 out ____________10.Investment Decision: Based on all the monetary considerations computed, which investment option should the company choose? Could be A or B BONUS ITEMS: 1. Defend your answer in Problem 7: No. 10. (3 points) __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ 2. In the periods of rising prices, suggest and discuss an inventory accounting method that will effectively minimize income tax. (3 points) LIFO_____________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ __________________________________________________________________________ -End of Examination- 11 | P a g e PCMA 412|Midterm Examination