Problem 16-7
Sherrod, Inc., reported pretax accounting income of $76 million for 2013.
The following information relates to differences between pretax
accounting income and taxable income.
a. Income from installment sales of properties included in pretax
accounting income in 2013 exceeded that reported for tax purposes by
$3 million. The installment receivable account at year-end had a
balance of $4 million (representing portions for 2012 and 2013
), expected
p
to be collected equally
q y in 2014 and 2015.
installment sales),
This will produce a deferred tax liability.
b. Sherrod was assessed a penalty of $2 million by the EPA for violation
of a federal law in 2013. The fine is to be paid in equal amounts in
2013 and 2014. This is a permanent difference, and should be added
back in determining taxable income.
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Problem 16-7 (continued)
c. Sherrod rents its operation facilities but owns one asset acquired in
2012 at a cost of $80 million. Depreciation is reported by the straightline method assuming a 4-year useful life. On the tax return,
depreciation will be more than straight-line depreciation in the first
two years, but less than straight-line depreciation in the next two years
($ in millions):
Income Statement
Tax Return
Difference
2012
$20
$26
$ (6)
2013
20
35
(15)
2014
20
12
8
2015
20
7
13
$80
$80
$0
This will produce a deferred tax liability that will begin reversing in
2014.
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Problem 16-7 (continued)
d. Warranty expense of $3 million is reported in 2013. For tax purposes,
the expense is deducted when costs are incurred, $2 million in 2013.
At December 31, 2013, the warranty liability was $2 million (after
adjusting entries). The balance was $1 million at the end of 2012.
This will produce a deferred tax asset.
e. In 2013, Sherrod accrued an expense and related liability for estimated
paid future absences of $7 million relating to the company’s new paid
vacation program. Future compensation will be deductible on the tax
return when actually paid in the next two years ($4 million in 2014; $3
million in 2015). This will produce a deferred tax asset.
f. During 2012, accounting income included an estimated loss of $2
million from having accrued a loss contingency. The loss is paid in
2013, at which time it is tax deductible. In 2012, this will produce a
deferred tax asset, that will reverse in 2013.
Balances in the deferred tax asset and deferred tax liability accounts at
January 2, 2013 were $1.2 million and $2.8 million respectively. The
enacted tax rate is 40% each year.
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Problem 16-7 (continued)
Part 1: Determine the amounts necessary to record income taxes for
2013, and prepare the appropriate journal entry.
Pretax accounting income (given)
$76
b. Add back permanent difference – fine
2
Adjusted pretax accounting income
$78
a. Deduct excess from installment sales
(3)
DTL
c. Deduct excess tax depreciation
(15) DTL
d Add excess warranty expense
d.
1
DTA
e. Add expense for future absences
7
DTA
f. Deduct loss contingency reversal
(2) DTA reversal
Taxable Income
$66
Tax expense (plug)
31.2
Deferred tax asset [40% x (1+7-2)]
2.4
Deferred tax liability [40% x (3+15)]
7.2
Taxes payable (40% x 66)
26.4
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Problem 16-7 (continued)
Part 2: What is the 2013 net income?
Pretax accounting income (given)
Less: Tax expense (computed in Part 1)
Net Income
$76.0
(31.2)
$44.8
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Problem 16-7 (continued)
Part 3: Show how any deferred tax amounts would be classified and
reported in the 2013 balance sheet.
From the Installment Receivable (a):
$0.8 as a current deferred tax liability (2014: 40% x $2)
$0.8 as a noncurrent deferred tax liability (2015: 40% x $2)
From the Depreciation (c):
$8.4 as a noncurrent deferred tax liability {40% x [(20+20) – (12+7)]}
From the Warranty Expense/Payable (d):
$0.8 as a current deferred tax asset (40% x $2)
From the Accrued Expense/Payable (e):
$1.6 as a current deferred tax asset (40% x $4)
$1.2 as a noncurrent deferred tax asset (40% x $3)
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Problem 16-7 (continued)
Current Deferred Tax Asset (0.8 + 1.6)
Current Deferred Tax Liability
Net Current Deferred Tax Asset
$2.4
(0.8)
$1.6
Noncurrent Deferred Tax Asset
Noncurrent Deferred Tax Liability (0.8 + 8.4)
y
Net Noncurrent Deferred Tax Liability
$1.2
(9.2)
$8.0
$
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