Qualified Disclaimers

admin — Mon, 13 Jul 2009 18:55:47 +0000

With reference to the estate tax, gift tax, and generation skipping transfer taxes, if a recipient makes a qualified disclaimer with respect to any interest in property within the estate of decedent or donor, the property will be treated as if it had never been transferred to the recipient.
An example of when this might be used wisely is as follows: John Doe dies unexpectedly and his will leaves everything to his wife and the will was written 30 years ago. If the wife now owns considerable assets in her name, she might prefer that part of the property in her husband’s estate pass to their children instead. By properly disclaiming some of the property designated to pass to her, she could reduce her estate taxes at her death (see an attorney for details on how this can be done).

Why Finance and Accounting Think Diﬀerently

admin — Sun, 14 Jun 2009 18:56:37 +0000

Both accountants and ﬁnanciers are interested in ﬁrm value. But the principal diﬀerence between them is that the accountants try to approximate changes in the current value of the ﬁrm, while the latter try to understand the exact timing of hard cash inﬂows and outﬂows over the entire future. The former want to learn about earnings, the latter want to learn about cash ﬂows.
The main diﬀerence between these two concepts of income and cash ﬂows are accruals: economic transactions that have delayed cash implications. For example, if I owe your ﬁrm $10,000
and have committed to paying you tomorrow, the accountant would record your current ﬁrm value to be $10,000 (perhaps time- and credit-risk adjusted). In contrast, the ﬁnancier would consider this to be a zero cash-ﬂow—until tomorrow, when the payment actually occurs. The contrast is that the accountant wants the ﬁnancial statements to be a good representation of the economic value of the ﬁrm today (i.e., you already own the payment commitment), instead of a representation of the exact timing of inﬂows and outﬂows. The ﬁnancier needs the timing of cash ﬂows for the NPV analysis instead.
Accruals can be classiﬁed into long-term accruals and short-term accruals. The primary long-term accrual is depreciation, which is the allocation of the cost of an asset over a period of time. For example, when a ﬁnancier purchases a maintenance-free machine, he sees a machine that costs a lot of cash today, and produces cash ﬂows in the future. If the machine needs to be replaced every 20 years, then the ﬁnancier sees a sharp spike in cash outﬂows every 20 years, followed by no further expenditures (but hopefully many cash inﬂows).
The accountant, however, sees the machine as an asset that uses up a fraction of its value each year. So, an accountant would try to determine an amount by which the machine deteriorates in each year, and would only consider this prorated deterioration to be the annual outﬂow (called an expense). The purchase of a $1 million machine would therefore not be an earnings reduction of $1 million in the ﬁrst year, followed by $0 in the remaining 19 years. Instead, it would be an expense of $50,000 in each of 20 years. (This is a very common method of depreciation and is called straight-line depreciation.)
To complicate matters further, accountants often use diﬀerent standardized depreciation schedules over which particular assets are depreciated. These are called impairment rules, and you already know the straight-line rule. Houses, for example, are commonly depreciated straight-line over 30 years—often regardless of whether the house is constructed of wood or brick. The predetermined value schedule is usually not accurate: For example, if investors have recently developed a taste for old buildings, it could be that a building’s value has doubled since its construction, even though the ﬁnancial statements might record this building to be worth nothing. (Even this is oversimpliﬁed. On occasion, accountants invoke procedures that allow them to reduce the value of an asset midway through its accounting life—but more often downward than upward.) Another common impairment rule is accelerated depreciation, which is especially important in a tax context. (But we are straying too far.)
If the machine happens to continue working after 20 years, the ﬁnancials which have just treated the machine as a $50,000 expense in Year 20 will now treat it as a $0 expense in Year 21. It remains worth $0 because it cannot depreciate any further—it has already been fully depreciated. The ﬁnancier sees no diﬀerence between Year 20 and Year 21, just as long as the machine continues to work.
Short-term accruals come in a variety of guises. To a ﬁnancier, what matters is the timing of cash coming in and cash going out. A sale for credit is not cash until the company has collected the cash. To the accountant, if the ﬁrm sells $100 worth of goods on credit, the $100 is booked as revenue (which ﬂows immediately into net income), even though no money has yet arrived. In the accounting view, the sale has been made. To reﬂect the delay in payment, accountants increase the accounts receivables by $100. (Sometimes, ﬁrms simultaneously establish an allowance for estimated non-payments [bad debts].)
Another short-term accrual is corporate income tax, which a ﬁnancier considers to be an outﬂow only when it has to be paid—at least not until (the corporate equivalent of) April 15 of the following year. However, on the income statement, when a ﬁrm in the 40% corporate tax bracket makes $100 in proﬁts, the income statement immediately subtracts the corporate income tax of $40 (which will eventually have to be paid on the $100 in proﬁts) and therefore records net income of only $60. To reﬂect the fact that the full $100 cash is still around, $40 is recorded as tax payables.
In sum, for a ﬁnancier, the machine costs a lot of cash today (so it is an immediate negative), theaccounts receivables are not yet cash inﬂows (so they are not yet positives), and the corporate income tax is not yet a cash outﬂow (so it is not yet a negative). For an accountant, the machine costs a prorated amount over a period of years, the accounts receivables are immediate positive earnings, and the corporate income tax is an immediate cost. There is deﬁnite sense in the approaches of both accounting and ﬁnance: the accounting approach is better in giving a snapshot impression of the ﬁrm’s value; the ﬁnance approach is better in measuring the timing of the cash inﬂows and cash outﬂows for valuation purposes. Note that valuation leans much more heavily on the assumption that all future cash ﬂows are fully considered. Today’s cash ﬂows alone would not usually make for a good snapshot of the ﬁrm’s situation.

Financial issues » Accounting

Qualified Disclaimers

Why Finance and Accounting Think Diﬀerently