Advanced Financial Accounting I
Chapter One
Accounting for Income tax
Introduction
Companies spend a considerable amount of time
and effort to minimize their income tax payments.
And with good reason, as income taxes are a
major cost of doing business for most companies.
Yet, at the same time, companies must present
financial information to the investment
community that provides a clear picture of
present and potential tax obligations and tax
benefits.
Fundamentals of Accounting for Income tax
• Corporations use guidelines to report information to investors and
creditors (IFRS) .
• Corporations also must file income tax returns following the
guidelines developed by the Internal Revenue Service (IRS).
• Because of IFRS and tax regulations differ in a number of ways, a
company reports as tax expense will differ from the amount of taxes
payable to the IRS.
Financial Vs Tax reporting
Pretax financial income Vs Taxable income
• Pretax financial income is a financial reporting term.
• It also is often referred to as income before taxes, income for financial
reporting purposes, or income for book purposes. Companies determine
pretax financial income according to IFRS to provide useful information
to investors and creditors.
• Taxable income (income for tax purposes) is a tax accounting term.
• It indicates the amount used to compute income taxes payable.
Companies determine taxable income according to the Internal Revenue
Code (the tax code). Income taxes provide money to support
government operations
Illustration
•To illustrate how differences in IFRS and tax
rules affect financial reporting and taxable
income, assume that Chelsea Inc. reported
revenues of $130,000 and expenses of
$60,000 in each of its first three years of
operations.
Illustration IFRS Vs Tax Reporting
1. CHELSEA INC. IFRS REPORTING
2017
2018
2019
Total
Revenues
$130,000
$130,000
$130,000
Expenses
60,000
60,000
60,000
Pretax financial income
$ 70,000
$ 70,000
$ 70,000
$210,000
Income tax expense (40%)
$ 28,000
$ 28,000
$ 28,000
$ 84,000
• For tax purposes Chelsea reported the same expenses to the IRS in
each of the years. But, Chelsea reported different taxable revenues
(due to Receivables) of $100,000 in 2017, $150,000 in 2018, and
$140,000 in 2019.
2. CHELSEA INC. TAX REPORTING
f
2017
2018
2019
Total
Revenues
$100,000
$150,000
$140,000
Expenses
60,000
60,000
60,000
Taxable income
$ 40,000
$ 90,000
$ 80,000
$210,000
Income taxes payable (40%)
$ 16,000
$ 36,000
$ 32,000
$ 84,000
Income tax expense Vs income tax payable
• For this example Income tax expense and income taxes payable
differed over the three years but were equal in total.
• Income tax expense and income taxes payable differed over the three
years but were equal in total
CHELSEA INC. INCOME TAX EXPENSE AND
INCOME TAXES PAYABLE
Income tax expense
Income taxes payable
Difference
2017
2018
2019
Total
$28,000
$28,000
$28,000
$84,000
16,000
36,000
32,000
84,000
$12,000
$ (8,000)
$ (4,000)
compiled by: Ashu G.
$ –0–
• Differences b/n income tax expense and income taxes
payable in this example arise for a simple reason (treat
account receivable differently).
• For financial reporting, companies use the full accrual
method to report revenues.
• For tax purposes, they use a modified cash basis.
• As a result, pretax financial income of $70,000 and income
tax expense of $28,000 for each of the three years.
• However, taxable income fluctuates. For example, in 2017
taxable income is only $40,000, so Chelsea owes just $16,000
to the IRS that year.
• As the above Illustration indicates, $12,000 ($28,000 − $16,000)
difference between income tax expense and income taxes
payable in 2017 reflects taxes that will be paid in future periods.
• This $12,000 difference is often referred to as a deferred tax
amount. In this case, it is a deferred tax liability (future
burden).
• In cases where taxes will be lower in the future, we record as
deferred tax asset (future benefit (tax save)).
Future Taxable Amounts and Deferred
Taxes
A temporary difference is a difference between the tax basis and book
basis of assets and liabilities in the financial statements, which will result
in taxable amounts or deductible amounts in future years.
Taxable amounts increase taxable income in future years.
Deductible amounts decrease taxable income in future years.
In the previous example, the only difference between the book basis and
tax basis of the assets and liabilities relates to accounts receivable that
arose from revenue recognized for book purposes. The illustration
indicates that Chelsea reports account receivable at $30,000.
Per Books
12/31/17
Per Tax Return
Accounts receivable
$30,000
Accounts receivable
12/31/17
$–0–
What will happen to the $30,000 temporary difference
that originated in 2017 for Chelsea?
Assuming Chelsea expects to collect $20,000 in 2018
and $10,000 in 2019, this collection results in future
taxable amounts of $20,000 in 2018 and $10,000 in
2019. These will cause taxable income exceed pretax
financial income.
• That is, companies recognize income taxes that are
payable when they recover the reported assets.
• Recognize the amount of income taxes that are
refundable when they settle liabilities.
Reversal of Temporary Difference
Deferred Tax Liability
A deferred tax liability represents the increase in taxes payable in future
years as a result of taxable temporary differences existing at the end of the
current year.
Based on Example, income taxes payable is $16,000 ($40,000 × 40%) in
2017. In addition, a temporary difference exists at year-end b/c revenue
and related A/R differently for book and tax purposes.
The book basis of A/R is $30,000, and the tax basis is zero. Thus, the total
deferred tax liability at the end of 2017 is $12,000.
Book basis of accounts receivable
$30,000
Tax basis of accounts receivable
Cumulative temporary difference at the end of 2017
Tax rate
Deferred tax liability at the end of 2017
–0–
30,000
40%
$12,000
Because it is the first year of operations for Chelsea, there is no deferred
tax liability at the beginning of the year. Income tax expense for 2017 will
be.
Deferred tax liability at end of 2017
Deferred tax liability at beginning of 2017
$12,000
–0–
Deferred tax expense for 2017
12,000
Current tax expense for 2017 (income taxes payable)
16,000
Income tax expense (total) for 2017
$28,000
• This computation indicates that income tax expense has two components
current tax expense & deferred tax expense.
• Deferred tax expense is the increase in the deferred tax liability balance from
the beginning to the end of the accounting period.
For Chelsea, it makes the following entry at the end of 2017.
Income Tax Expense
28,000
Income Taxes Payable
Deferred Tax Liability
16,000
12,000
• At the end of 2018 (2nd year), the d/c b/n the book basis and the tax basis of the
A/R is $10,000. Chelsea’s deferred tax liability is $4,000 ($10,000 × 40%), which it
reports at the end of 2018. Income taxes payable for 2018 is $36,000 and the
income tax expense for 2018 is $28,000.
Deferred tax liability at end of 2018
$ 4,000
Deferred tax liability at beginning of 2018
Deferred tax expense (benefit) for 2018
12,000
(8,000)
Current tax expense for 2018 (income taxes payable)
36,000
Income tax expense (total) for 2018
Income Tax Expense 28,000
Deferred Tax Liability
8,000
Income Taxes Payable
$28,000
36,000
• At the end of 2019 (3rd and final year), the d/ce b/n the book basis and the
tax basis of the A/R is zero. Income taxes payable for 2019 is $32,000 and
the income tax expense for 2019 is $28,000.
Income Tax Expense
28,000
Deferred Tax Liability
4,000
Income Taxes Payable 32,000
Financial Statement Effects
For the Balance Sheet income taxes payable will be reported as
current liability, and the deferred tax liability is reported as a
noncurrent liability.
Income Taxes Payable
Deferred Tax Liability
2017
2018
$16,000
36,000
2019
32,000
$12,000
4,000
−0−
Year-End
For Income Statement, Income Tax Expense will be Presented
totally or separately as current tax and differed tax.
For the Year Ended
Income before income taxes
Income tax expense
Net income
2017
$70,000
28,000
$42,000
2018
$70,000
28,000
$42,000
2019
$70,000
28,000
$42,000
Future Deductible Amounts and Deferred Taxes
Deductible amounts decrease taxable income in future years.
Assume that during 2017, Cunningham Inc. estimated its warranty costs
related to the sale of microwave ovens to be $500,000, paid evenly over
the next two years.
For book purposes, Cunningham reported warranty expense and a
related estimated liability for warranties of $500,000.
For tax purposes, the warranty tax deduction is not allowed until paid.
When Cunningham pays the warranty liability, it reports an
expense (deductible amount) for tax purposes. Because of this
temporary difference, should recognize in 2017 the tax benefits
(positive tax consequences) for the tax deductions that will
result from the future settlement of the liability. Cunningham
reports this future tax benefit in the Dec 31, 2017, balance sheet
as a deferred tax asset.
Deductible amounts occur in future tax returns. These future
deductible amounts cause taxable income to be less than
pretax financial income in the future as a result of an existing
temporary difference.
Cunningham’s temporary difference originates
(arises) in one period (2017) and reverses over the
future
two
periods
(2018
and
2019).
Deferred Tax Asset
• A deferred tax asset represents the increase in taxes refundable (or
saved) in future years as a result of deductible temporary differences
existing at the end of the current year.
To illustrate, assume that Hunt Company has revenues of $900,000
for both 2017 and 2018. It also has operating expenses of $400,000 for
each of these years. In addition, Hunt accrues a loss and related
liability of $50,000 for financial reporting purposes because of
pending litigation.
Hunt cannot deduct this amount for tax purposes until it pays the
liability, expected in 2018. As a result, a deductible amount will
occur in 2018 when Hunt settles the liability, causing taxable income
to be lower than pretax financial information.
IFRS Reporting
2017
Revenues
Expenses (operating)
Litigation loss
Pretax financial income
Tax rate
Income tax expense
$900,000
400,000
50,000
$450,000
40%
$180,000
2018
$900,000
400,000
−0−
$500,000
40%
$200,000
Tax Reporting
Revenues
Expenses (operating)
Litigation loss
Taxable income
Tax rate
Income taxes payable
2017
$900,000
400,000
−0−
$500,000
40%
$200,000
2018
$900,000
400,000
50,000
$450,000
40%
$180,000
• In this case, Hunt records a deferred tax asset of $20,000 at
the end of 2017 because it represents taxes that will be saved
in future periods.
• Computation of the deferred tax asset at the end of 2017
(assuming a 40% tax rate) will be.
Book basis of litigation liability
Tax basis of litigation liability
Cumulative temporary difference at the end of 2017
Tax rate
Deferred tax asset at the end of 2017
$50,000
–0–
50,000
40%
$20,000
• Assuming that 2017 is Hunt’s first year of operations and
income taxes payable is $200,000, Hunt computes its income
tax expense as follows.
Deferred tax asset at end of 2017
$ 20,000
Deferred tax asset at beginning of 2017
Deferred tax benefit (Save) for 2017
–0–
(20,000)
Current tax expense for 2017 (income taxes payable)
200,000
Income tax expense (total) for 2017
$180,000
• The deferred tax benefit results from the increase in the
deferred tax asset from the beginning to the end of the
accounting period. The deferred tax benefit is a negative
component of income tax expense.
• The total income tax expense of $180,000 on the income
statement for 2017 thus consists of two elements—current tax
expense of $200,000 and a deferred tax benefit of $20,000.
• Hunt makes the following journal entry.
Income Tax Expense
Deferred Tax Asset
Income Taxes Payable
180,000
20,000
200,000
Income tax expense for 2018
Deferred tax asset at the end of 2018
$ –0–
Deferred tax asset at the beginning of 2018
20,000
Deferred tax benefit (Save) for 2018
Current tax expense for 2018 (income taxes payable)
Income tax expense (total) for 2018
20,000
180,000
$200,000
The company records income taxes for 2018 as follows.
Income Tax Expense
200,000
Deferred Tax Asset
Income Taxes Payable
20,000
180,000
• The total income tax expense of $200,000 on the income statement for
2018 thus consists of two elements.
current tax expense of $180,000 and
deferred tax expense of $20,000.
Financial Statement Effects
For Balance Sheet Hunt Company reports the following
information on its balance sheets for 2017 and 2018 as shown in
Illustration.
• Income taxes payable is reported as a current liability, and the
deferred tax asset is reported as a noncurrent asset.
For Income statement; On its income statement,
Hunt Company reports the information as shown
in Illustration.
HUNT COMPANY INCOME STATEMENT
FOR THE YEAR ENDING DECEMBER 31, 2017
Revenues
Expenses (operating)
Litigation loss
Income before income taxes
Income tax expense
Current
Deferred
Net income
$900,000
400,000
50,000
450,000
$200,000
(20,000)
180,000
$270,000
Temporary Vs Permanent Differences
1.
Temporary Difference
• Taxable temporary differences are differences that will result in taxable
amounts in future years when the related assets are recovered.
• Taxable temporary differences give rise to recording deferred tax liabilities.
• Deductible temporary differences are differences that will result in
deductible amounts in future years when the related book liabilities are
settled.
• Deductible temporary differences give rise to recording deferred tax assets.
Temporary Difference …………Cont;d
• Determining a company’s temporary differences may prove difficult.
A company should prepare a balance sheet for tax purposes that it
can compare with its IFRS balance sheet. Many of the differences
between the two balance sheets are temporary differences.
Originating and Reversing Temporary Differences.
• An originating temporary difference is the initial difference
between the book basis and the tax basis of an asset or liability,
regardless of whether the tax basis of the asset or liability exceeds or
is exceeded by the book basis of the asset or liability.
• A reversing difference, on the other hand, occurs when eliminating
a temporary difference that originated in prior periods and then
removing the related tax effect from the deferred tax account.
Example
Assume that Sharp Co. has tax depreciation in excess of book depreciation
of $2,000 in 2015, 2016, and 2017. Further, it has an excess of book
depreciation over tax depreciation of $3,000 in 2018 and 2019 for the
same asset. Assuming a tax rate of 30% for all years involved, the Deferred
Tax Liability account reflects the following.
• The originating differences for Sharp in each of the first three years are
$2,000. The related tax effect of each originating difference is $600. The
reversing differences in 2018 and 2019 are each $3,000. The related tax
effect of each is $900.
2. Permanent differences
 Permanent differences result from items that (1) enter into pretax financial
income but never into taxable income, and vise versa.
 Congress has enacted a variety of tax law provisions to attain certain
political, economic, and social objectives.
 Some of these provisions exclude certain revenues from taxation, limit
the deductibility of certain expenses, and permit the deduction of certain
other expenses in excess of costs incurred.
• Since permanent differences affect only the period in which they occur,
they do not give rise to future taxable or deductible amounts. As a result,
companies recognize no deferred tax consequences.
Examples of Permanent Differences
Items recognized for financial reporting purposes but not for tax purposes.
1.
2.
3.
4.
Interest received on state and municipal obligations.
Expenses incurred in obtaining tax-exempt income.
Proceeds from (Premiums paid for) life insurance carried by the
company on key officers or employees.
Fines and expenses resulting from a violation of law.
Items recognized for tax purposes but not for financial reporting purposes.
1.
2.
“Percentage depletion” of natural resources in excess of their cost.
The deduction for dividends received from Gov’t corporations.
Illustrations of Temporary and Permanent Differences
• Assume that Bio-Tech Company reports pretax financial income of
$200,000 in each of the years 2015,16, and 17. The company is subject to
a 30% tax rate and has the following differences between pretax financial
income and taxable income.
1. It pays life insurance premiums for its key officers of $5,000 in 2016 and
2017. Although not tax-deductible, Bio-Tech expenses the premiums for
book purposes.
1. Bio-Tech reports gross profit of $18,000 from an installment sale in
2015 for tax purposes over an 18-month period at a constant amount
per month beginning January 1, 2016. It recognizes the entire amount
for book purposes in 2015.
• The installment sale is a temporary difference, whereas
the life insurance premium is a permanent difference.
Pretax financial income
2015
$200,000
2016
$200,000
2017
$200,000
5,000
5,000
(18,000)
182,000
12,000
217,000
6,000
211,000
30%
30%
30%
$ 54,600
$ 65,100
$ 63,300
Permanent Difference
(Non-deductible expense )
Temporary difference
(Installment sale)
Taxable income
Tax rate
Income taxes payable
Interpretation
Bio-Tech deducts the installment-sales gross profit from pretax
financial income to arrive at taxable income Because Pretax
financial income includes the installment-sales gross profit;
taxable income does not.
Conversely, it adds the $5,000 insurance premium to pretax
financial income to arrive at taxable income Because Pretax
financial income records an expense for this premium, but not for
tax purposes.
Therefore, the life insurance premium must be added back to
pretax financial income to reconcile to taxable income.
December 31, 2015
Income Tax Expense ($54,600 + $5,400)
60,000
5,400
Deferred Tax Liability ($18,000 × 30%)
Income Taxes Payable ($182,000 × 30%)
54,600
December 31, 2016
Income Tax Expense ($65,100 – $3,600)
Deferred Tax Liability ($12,000 × 30%)
61,500
3,600
Income Taxes Payable ($217,000 × 30%)
65,100
December 31, 2017
Income Tax Expense ($63,300 – $1,800)
Deferred Tax Liability ($6,000 × 30%)
Income Taxes Payable ($211,000 × 30%)
61,500
1,800
63,300
Bio-Tech has one temporary difference, which originates in 2015 and
reverses in 2016 and 2017. As the temporary difference reverses, Bio-Tech
reduces the deferred tax liability.
There is no deferred tax amount associated with the difference caused by the
nondeductible insurance expense because it is a permanent difference.
Although an enacted tax rate of 30% applies for all three years, the effective
rate differs from the enacted rate in 2016 and 2017. Bio-Tech computes the
effective tax rate by dividing total income tax expense for the period by
pretax financial income.
The effective rate is 30% for 2015 ($60,000 ÷ $200,000 = 30%) and 30.75%
for 2016 and 2017 ($61,500 ÷ $200,000).
Revision of Future Tax Rates
When a change in the tax rate is enacted, companies should record its
effect on the existing deferred income tax accounts immediately. A
company reports the effect as an adjustment to income tax expense in the
period of the change.
Assume that on December 10, 2017, a new income tax act is signed into
law that lowers the corporate tax rate from 40%to 35%, effective January
1, 2019. If Hostel Co. has one temporary difference at the beginning of
2017 related to $3 million of excess tax depreciation, then it has a
Deferred Tax Liability account with a balance of $1,200,000 ($3,000,000 ×
40%) at January 1, 2017. If taxable amounts related to this difference are
scheduled to occur equally in 2018, 2019, and 2020, the deferred tax
liability at the end of 2017 is $1,100,000, computed as follows.
2018
2019
2020
Total
Future taxable amounts
$1,000,000
$1,000,000
$1,000,000
$3,000,000
Tax rate
Deferred tax liability
40%
$ 400,000
35%
$ 350,000
35%
$ 350,000
$1,100,000
.
Hostel, therefore, recognizes the decrease of $100,000 ($1,200,000 – $1,100,000) at the end of 2017 in
the deferred tax liability as follows.
Deferred Tax Liability 100,000
Income Tax Expense
100,000
• Corporate tax rates do not change often. Therefore, companies usually employ the current
rate.
• However, state and foreign tax rates change more frequently, and they require adjustments
in deferred income taxes accordingly.
ACCOUNTING FOR NET OPERATING LOSSES
• Net operating loss (NOL) occurs for tax purposes,
when tax-deductible expenses exceed taxable
revenues.
• For an established company, a major event such
as
• a labor strike,
• rapidly changing regulatory and competitive forces,
• a disaster such as 9/11, or
• a general economic recession can cause expenses
exceed revenues—a net operating loss.
ACCOUNTING FOR NET OPERATING LOSSES
• Inequitable tax burden would result if companies
were taxed during profitable periods without
receiving any tax relief during periods of net
operating losses.
• Companies accomplish this income-averaging
provision (losses of one year to offset the profits
of other years) through the
• carryback and carryforward of net operating losses.
Loss Carryback
• CARRYBACKS. Deductions or credits that cannot be utilized on the tax
return during a year and that may be carried back to reduce taxable
income or taxes paid in a prior year.
• Through use of a loss carryback, a company may carry the net operating
loss back two years and receive refunds for income taxes paid in those
years.
• The company must apply the loss to the earlier year first and then to the
second year.
Example
• To illustrate the accounting procedures for a net operating loss carryback,
assume that Groh Inc. has no temporary or permanent differences.
Year
2014
2015
2016
2017
Taxable Income or Loss
$ 50,000
100,000
200,000
(500,000)
Tax Rate
35%
30%
40%
—
Tax Paid
$17,500
30,000
80,000
–0–
• In 2017, Groh incurs a net operating loss that it decides to carry back.
• Groh Inc must carries the loss back first to 2015. Then, Groh carries back
any unused loss to 2016.
• Accordingly, Groh files amended tax returns for 2015 and 2016, receiving
refunds for the $110,000 ($30,000 + $80,000) of taxes paid in those years.
For accounting as well as tax purposes, the $110,000 represents the tax effect
(tax benefit) of the loss carryback. Groh should recognize this tax effect in 2017,
the loss year.
Income Tax Refund Receivable
110,000
Benefit Due to Loss Carryback (Income Tax Expense) 110,000
• Groh reports the account debited, Income Tax Refund Receivable, on the balance
sheet as a current asset at December 31, 2017. It reports the account credited on
the income statement for 2017.
• Since the $500,000 net operating loss for 2017 exceeds the $300,000 total taxable
income from the 2 preceding years, Groh carries forward the remaining $200,000
loss.
Loss carryforwards
• CARRYFORWARDS. Deductions or credits that cannot be utilized on the
tax return during a year and that may be carried forward to reduce
taxable income or taxes payable in a future year
• If a carryback fails to fully absorb a net operating loss or if the company
decides not to carry the loss back, then it can carry forward. Because
companies use carryforwards to offset future taxable income, the tax effect
of a loss carryforward represents future tax savings.
Example
Return to the Groh example In 2017, the company records the tax
effect of the $200,000 loss carryforward as a deferred tax asset of
$80,000 ($200,000 × 40%), assuming that the enacted future tax
rate is 40%. Groh records the benefits of the carryback and the
carryforward in 2017 as follows.
• Groh realizes the income tax refund receivable of $110,000
immediately as a refund of taxes paid in the past. It establishes
a Deferred Tax Asset account for the benefits of future tax
savings.
• The two accounts credited are contra income tax expense items,
which Groh presents on the 2017 income statement .
• The current tax benefit of $110,000 is the income tax refundable
for the year.
• The $80,000 is the deferred tax benefit for the year, which
results from an increase in the deferred tax asset
Computation of Income Taxes Payable with Realized Loss
Carryforward
• For 2018, assume that Groh returns to profitable operations and
has taxable income of $250,000 (prior to adjustment for the NOL
carryforward), subject to a 40% tax rate. Groh then realizes the
benefits of the carryforward for tax purposes in 2018, which it
recognized for accounting purposes in 2017. Groh computes the
income taxes payable for 2018.
Taxable income prior to loss carryforward
Loss carryforward deduction
Taxable income for 2018
Tax rate
Income taxes payable for 2018
$ 250,000
(200,000)
50,000
40%
$ 20,000
• Groh records income taxes in 2018 as follows.
Income Tax Expense
Deferred Tax Asset
Income Taxes Payable
100,000
80,000
20,000
• The benefits of the NOL carryforward, realized in 2018, reduce
the Deferred Tax Asset account to zero.
Carryforward with Valuation Allowance
VALUATION ALLOWANCE. The portion of a deferred tax asset for which
it is more likely than not that a company will not realize a tax benefit.
• Assume that it is more likely than not that Groh will not realize
the entire NOL carryforward in future years.
• In this situation, Groh records the tax benefits of $110,000
associated with the $300,000 NOL carryback, as we previously
described.
• In addition, it records Deferred Tax Asset of $80,000 ($200,000 ×
40%) for the potential benefits related to the loss carryforward,
and an allowance to reduce the deferred tax asset by the same
amount
FINANCIAL STATEMENT PRESENTATION
1. Balance Sheet
• Income taxes payable and income tax refund receivable are
reported as a current liability and current asset, respectively, on
the balance sheet.
• Deferred tax assets and deferred tax liabilities are separately
recognized and measured and then offset on the balance sheet.
• The net deferred tax asset or net deferred tax liability is therefore
reported in the noncurrent section of the balance sheet.
Income Statement
• Companies are required to report income before taxes and
income tax expense on the income statement.
• Income tax expense generally equals the sum of income taxes
payable and the change in the deferred tax expense.
• Income tax benefit generally equals the sum of income taxes
refundable and the change in the deferred tax benefit.
• For example, a company adds an increase in a deferred tax
liability to income taxes payable. On the other hand, it subtracts
an increase in a deferred tax asset from income taxes payable.
Summary
Illustration
COMPREHENSIVE EXAMPLE
• Allman Company, which began operations at the beginning of
2016, produces various products on a contract basis.
• Each contract generates a gross profit of $80,000. Some of
contracts provide for the customer on an installment basis.
• Under these contracts, Allman collects one-fifth (20%) of the
contract revenue in each of the following four years.
• For financial reporting purposes, the company uses accrual
basis and for tax purposes, Allman uses installment basis (cash
basis ).
Information related to Allman’s operations for
2016 are given below.
1. In 2016, the company completed seven (7) contracts that allow for the
customer to pay on an installment basis. Allman recognized the related
gross profit of $560,000 (7 x 80,000) for financial reporting purposes. It
reported only $112,000 (20% x 560,000) of gross profit on installment sales
on the 2016 tax return. The company expects future collections on the
related installment receivables to result in taxable amounts of $112,000 in
each of the next four years.
2. At the beginning of 2016, Allman Company purchased depreciable assets
with a cost of $540,000. For book purposes, Asset depreciates using the
SLM over 6 yrs. For tax purposes, the assets fall in the five-year recovery
class, and Allman uses the MACRS system.
Depreciation computation
Year
2016
Depreciation for Book Purposes
Depreciation for Tax Purposes
$ 90,000
$108,000
Difference
$(18,000)
2017
90,000
172,800
(82,800)
2018
90,000
103,680
(13,680)
2019
90,000
62,208
27,792
2020
90,000
62,208
27,792
2021
90,000
31,104
58,896
$540,000
$540,000
$ –0–
1. During 2016, the product warranty liability accrued for book
purposes was $200,000, and the actual paid for warranty liability
was $44,000. Allman expects to settle the remaining $156,000 by
expenditures of $56,000 in 2017 and $100,000 in 2018.
2. In 2016, nontaxable municipal bond interest revenue was $28,000.
3. In 2016, nondeductible fines and penalties of $26,000 were paid.
4. Pretax financial income for 2016 amounts to $412,000.
5. Tax rates enacted up to 2016 were 50% and for 2017 and later years
40%.
Required
1. Identify temporary and permanent differences?
2. Determine taxable income of 2016?
3. Computes income taxes payable for 2016?
4. Compute future taxable amount (DTL) at the end of 2016?
5. Compute future deductible amount (DTA) at the end of 2016?
6. Compute net deferred tax expense (DTL - DTA) for 2016?
7. Compute total income tax expense (deferred + current) of 2016?
8. Records income taxes payable, deferred income taxes, and income tax expense
of 2016?
9. Show the financial presentation.
Solution
Do it!