Chapter 16: Accounting for Corporate Income Tax
Suggested Time
Case
16-1
16-2
16-3
Ringo Incorporated
Software Incorporated
Deep Harbour Limited
Technical Review
TR16-1
TR16-2
TR16-3
TR16-4
TR16-5
Temporary versus Permanent Difference
Calculation Taxes Payable
Temporary Differences
Deferred Tax Balances and Income Tax Expense
CCA-Depreciation Differences
Assignment A16-1
A16-2
A16-3
A16-4
A16-5
A16-6
A16-7
A16-8
A16-9
A16-10
A16-11
A16-12
A16-13
A16-14
A16-15
A16-16
A16-17
A16-18
A16-19
A16-20
A16-21
A16-22
A16-23
A16-24
A16-25
A16-26
A16-27
A16-28
A16-29
A16-30
Income Tax Allocation—Two-Year Period ................................... 15
Deferred Tax Balances………………………………………….. 20
Income Tax Allocation—Two-Year Period ................................... 15
Income Tax Allocation, Alternatives (*W) .................................... 35
Cumulative CCA-Depreciation Differences .................................. 30
Cumulative Temporary Differences ............................................... 30
Tax Calculations…………………………………………………. 25
Tax Calculations ............................................................................ 20
Tax Calculations ............................................................................ 20
Tax Calculations ............................................................................ 25
Tax Calculations ............................................................................ 20
Tax Calculations ............................................................................ 20
Deferred Income Tax; Change in Tax Rates (*W) ........................ 20
Deferred Income Tax; Change in Tax Rates (*W) ........................ 40
Deferred Income Tax; Change in Tax Rates .................................. 30
Tax Calculations; Change in Tax Rates ......................................... 30
Tax Calculations; Change in Tax Rates………………………… 30
Tax Calculations—Tax Rate Change ............................................. 40
Tax Calculations—Tax Rate Change ............................................. 35
Tax-Rate Change; Two-Stage ........................................................ 35
Tax Calculations ............................................................................ 30
Tax Calculations; Rate Change ...................................................... 30
Tax Calculations; Rate Change (*W) ............................................ 40
Tax Calculations ............................................................................ 40
Tax Expense; Comprehensive ........................................................ 35
Tax Expense; Comprehensive ........................................................ 35
Tax Calculations; Comprehensive ................................................. 50
Investment Tax Credit (Appendix) ................................................ 40
Tax Calculations, Rate Change (ASPE)………………………… 15
Tax Calculations (ASPE)………………………………………… 20
*W
The solution to this assignment is on the text website, Connect.
The solution is marked WEB.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-1
Questions
1.
It is common for companies to label income tax expense as a provision to cover all
circumstances. When a company has a loss the entry for income tax may be a credit
rather than a debit. Rather than switch from expense to benefit they use the word
provision.
2.
Differences between accounting and taxable income can be:
a) Temporary differences—asset or liability where accounting and tax basis are
different. The differences are included in accounting income in one period and in
taxable income in another period (under tax law). Temporary differences reverse
in one or more subsequent periods; they require interperiod income tax
allocation.
b) Permanent differences—items which are reported on the income statement or tax
return but not on both. They do not reverse; they are not subject to income tax
allocation.
3
a) Straight-line versus accelerated amortization causes a temporary difference
because (1) the amounts in the financial statements will differ from those in the
tax return, and (2) the tax effect will reverse or turn around over the life of the
asset.
b) Golf club dues cause a permanent difference because (1) the expense is
recognized for accounting purposes but not for income tax purposes and (2) the
differences will not reverse or turn around in any subsequent period.
4.
A temporary difference is said to originate when the difference between accounting
and taxable income first arises, or if it is increasing in a given direction. A reversal
follows origination and causes the accumulated temporary difference to decrease.
5.
Examples of permanent differences: (see also Exhibit 16-1)
 dividends received from taxable Canadian corporations
 equity earnings of significantly–influenced investees
 golf club dues.
Examples of temporary differences: (see also Exhibit 16-1)
 depreciation vs. CCA
 warranty expense vs. claims paid
 sales revenue vs. cash collected (contracts where payment is delayed)
 fair value gains/losses (i.e. derivatives mark-to-market)
 foreign exchange mark-to-market
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-2
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
6.
The two alternatives that exist to deal with the extent of tax allocation (i.e., the extent
to which temporary differences are allowed to give rise to deferred income tax
balances and tax expense):
a) No allocation: Income tax expense equals tax payable or receivable and no
deferrals exist. This option is only allowed in ASPE not in IFRS.
b) Comprehensive or full allocation: All temporary differences cause deferred or
future income tax and affect tax expense.
7.
Discounting is considered inappropriate for deferred income tax liabilities because
both the discount rate and the timing of reversals are difficult to determine. This is
explicitly not allowed in the standards.
8.
20x4
Income tax payable .................. $60,0001
Income tax expense .................. 40,0001
1
($100,000 + $50,000) x .4
2
($500,000 – $50,000) x .4
20x5
20x6
$120,000 $180,0002
120,000 200,0002
Total
$360,000
360,000
Income tax expense and income tax payable are equal over time because the
temporary difference has reversed.
9.
Income tax expense ($80,000 + $20,000 – $15,000)………… 85,000
Deferred income tax asset (Given) ........................................... 15,000
Deferred income tax liability (Given) ..................................
Income tax payable ($200,000 x .40) ...................................
20,000
80,000
10. Balance in deferred income tax: $80,000 ($200,000 x .40)
11. The accounting carrying value of the gain at the end of year 1 is $1,000,000: the
receivable. The tax basis of the gain is zero, as nothing has been recognized for tax
purposes. The balance in deferred income tax would be $400,000 at the end of Years
1 and 2, (a credit), $350,000 at the end of Year 3, and zero at the end of Year 4.
12. The tax basis of the assets is $900,000 ($1,000,000 - $100,000). The accounting
carrying value of the assets is $800,000 ($1,000,000 - $200,000). This would result
in a deferred tax asset of $20,000 (($900,000 - $800,000) x .20.)
13. Statement of financial position items have a different accounting and tax basis when
their treatment is different for tax and accounting purposes. This is usually because
the timing of the related revenue or expense takes place in different periods for
accounting than for tax. One has to imagine a tax statement of financial position, and
compare book values for tax to the accounting statement of financial position.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-3
14. The tax basis and accounting carrying value of statement of financial position items
related to permanent differences are identical.
15. Deferred income taxes may be debits or credits on the statement of financial position.
They are debits if originating temporary differences cause,
a) Tax expense to be less than accounting expense.
b) Tax revenue to be more than accounting revenue.
They are credits if originating temporary differences cause,
a) Tax expense to be more than accounting expense.
b) Tax revenue to be less than accounting revenue.
A debit to a future income tax account may either increase or decrease the account,
depending on its nature (asset or liability/ deferred credit), as may a credit.
16. If the tax rate were to decrease when the liability method was used, the deferred
income tax account would decline, remeasured using the new tax rate.
17. Most of the differences between effective and statutory rates are explained by
permanent differences. Another factor is different tax rates in other jurisdictions
(other examples exist), when the business operates globally.
18. An investment tax credit is a reduction in tax payable that a corporation is given
because of a qualifying expenditure of some type.
19. a) The flow-through approach, where the reduction to income tax payable directly
reduces the tax expense and thus income for the year increases.
b) The cost-reduction approach, where the ITC is deducted from the expenditure
that qualified for the ITC. Since the ITC relates to a capital asset, the ITC will
end up amortized to income over a period of years.
20. An ITC that relates to a capital asset can be shown on the statement of financial
position, to the extent it has yet to be depreciated, as,
a) A deduction from the related asset, or
b) A separate deferred credit.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-4
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Cases
Case 16-1 Ringo Incorporated
Overview:
The purpose of this case is to understand the future tax implications related to capital
assets. The student is required to calculate the accounting book value, the tax value and
as a result the temporary difference and the future tax amount. Further, the student is
required to understand the accounting implications of a change in accounting policy and
how a change in accounting policy regarding the treatment of depreciation on capital
assets impacts the future tax accounts.
Issues:
1. Future taxes
2. Capital cost allowance/amortization calculations
3. Change in accounting policy
Analysis and Conclusions:
As the bank requires that the capital assets be accounted for using the future taxes
method, this would qualify as a change in accounting policy. ASPE Handbook section
1506.09(f) states that an entity can change from the taxes payable method, to the future
tax method, without meeting the general conditions required for a change in accounting
policy found in 1506.06. It is not required to show how the change results in more
relevant and reliable information for the users. As such this change qualifies, as a change
in accounting policy and 1506.10 requires that the change be accounting for
retrospectively.
As ASPE requires that comparative financial statements be presented, paragraph 1506.13
states that all changes be adjusted on the balance sheet of each component of equity
affected (in this case retained earnings). As a result, the accounting policy change would
first be reflected the December 31st, 20x12 comparative financial statements. The
calculations related to this change can be found in Exhibit II. In order to determine what
the future income tax asset or liability would be on the opening balance sheet, a detailed
calculation of depreciation was prepared and a detailed calculation of capital cost
allowance was prepared. As a result of the change in accounting policy from the taxes
payable method, to the future taxes method a future income tax liability would be
recorded for $145,070. The January 1st, 20x12 opening retained earnings balance will
decrease by $133,130 and the closing retained earnings will decrease by $145,070. A
future income tax expense of $11,940 will be recorded on the 20x12 financial statements.
Exhibit I shows a summary of changes to the financial statements.
As a result of the changes described above, the January 1st, 20x13 retained earnings will
also be decreased by $145,070. The December 31st, 20x13 future income tax liability
would be $193,527 (2012 - $145,070), which would result in a future income tax expense
of $48,457.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-5
The old capital assets were re-evaluated during 20x13 and several incurred changes to the
residual value and/or useful life. These changes qualify as a change in estimate, and are
dealt with prospectively under 1506.23. These changes would affect the net book value
of the assets and therefore were considered in the calculations of future income tax
amounts. In order to calculate the depreciation for 20x13, the book value on January 1st,
20x13 served as the new depreciation base prospectively. The new useful life and
or/residual value were then applied to calculate the new depreciation. The new
calculations for depreciation are found in exhibit II.
The new capital assets were added in to the book value and un-depreciated capital cost
calculations in order to determine the appropriate future income tax amount to record.
Exhibit I – Summary of changes on the financial statements
Schedule of Impact on Financial Statements
Balance Sheet 20x12
Future Income Tax Liability
Retained Earnings (Opening)
Retained Earnings Closing
145,070.39
(133,130.15)
(145,070.39)
Income Statement 20x12
Future Income Tax Expense
11,940.23
Balance Sheet 20x13
Future Income Tax Liability
193,527.41
Income Statement 20x13
Future Income Tax Expense
48,457.02
Exhibit II – Future Tax Calculations
Book Value Calculations:
Item
Purchase
Price
498,645
20x9
Depreciatio
n*
41,487.69
20x10
Depreciatio
n
47,414.50
20x11
Depreciatio
n
47,414.50
Total
Depreciatio
n
136,316.69
December
31, 20x11
Book Value
362,328.31
20x12
Depreciatio
n
47,414.50
December
31, 20x12
Book Value
314,913.81
20x13
Depreciatio
n
39,364.23
December
31, 20x13
Book Value
275,549.59
Manufacturi
ng Machine
#1
Manufacturi
ng Machine
#2
Manufacturi
ng Machine
#3
Office
Furniture
Lap Top
368,950
31,561.25
36,070.00
15,300.00
103,701.25
265,248.75
36,070.00
229,178.75
18,910.73
210,268.02
156,000
2,550.00
15,300.00
15,300.00
33,150.00
122,850.00
15,300.00
107,550.00
9,955.00
97,595.00
17,800
1,557.50
1,780.00
1,780.00
5,117.50
12,682.50
1,780.00
10,902.50
1,090.25
9,812.25
10,560
1,540.00
1,760.00
1,760.00
5,060.00
5,500.00
1,760.00
3,740.00
935.00
2,805.00
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-6
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Computers
Building
Manufacturi
ng Machine
#4
Manufacturi
ng Machine
#5
Manufacturi
ng Machine
#6
Total
797,000
562,350
23,245.83
26,566.67
26,566.67
76,379.17
720,620.83
694,054.17
-
15,423.43
37,261.15
678,630.74
525,088.85
678,900
-
58,918.13
619,981.88
110,000
-
18,497.50
91,502.50
128,891
1,360,339
200,355
2,511,234
20x12 CCA
20x13 CCA
62,305.69
December
31, 20x12
Book Value
145,379.95
43613.9849
December
31, 20x13
Book Value
101,765.96
3,200,205
101,942
128,891
128,891
359,725
1,489,230
*Only considers 10.5 months (with the exception of Machine #3 – only considers 2 months)
26,566.67
Tax Value Calculations:
Item
Purchase
Price
20x9 CCA*
20x10 CCA
20x11 CCA
Total CCA
Manufacturi
ng Machine
#1
Manufacturi
ng Machine
#2
Manufacturi
ng Machine
#3
Office
Furniture
Lap Top
Computers
Building
Manufacturi
ng Machine
#4
Manufacturi
ng Machine
#5
Manufacturi
ng Machine
#6
Total
498,645
74,796.75
127,154.48
89,008.13
290,959.36
December
31, 20x11
Book Value
207,685.64
368,950
55,342.50
94,082.25
65,857.58
215,282.33
153,667.68
46,100.30
107,567.37
32270.2118
75,297.16
156,000
23,400.00
39,780.00
27,846.00
91,026.00
64,974.00
19,492.20
45,481.80
13644.54
31,837.26
17,800
1,780.00
3,204.00
2,563.20
7,547.20
10,252.80
2,050.56
8,202.24
1640.448
6,561.79
10,560
10,560.00
-
-
10,560.00
-
-
-
0
-
797,000
562,350
15,940.00
31,242.40
29,992.70
77,175.10
719,824.90
28,793.00
691,031.90
27641.276
84,352.50
663,390.62
477,997.50
678,900
101,835.00
577,065.00
110,000
16,500.00
93,500.00
321,498
2,027,415.3
0
3,200,205
181,819
295,463
215,268
692,550
1,156,405
158,742
997,663
*Considers the half year rule (with the exception of Lap Top computers where the half year rule does not apply)
CCA Rates
Class 1,
4%,
Building
Class 8,
20%,
Furniture
Class 43,
30%
Manufacturi
ng
Equipment
Lap Top
Computers,
100%, No
half year
rule
Future Tax Calculations:
Calculated of
Future Tax
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-7
Amounts
Item
Manufacturin
g Machine #1
Manufacturin
g Machine #2
Manufacturin
g Machine #3
Office
Furniture
Lap Top
Computers
Building
Manufacturin
g Machine #4
Manufacturin
g Machine #5
Manufacturin
g Machine #6
Total
December
31, 20x11
Book Value
362,328.31
December
31, 20x11
Tax Value
207,685.64
Temporary
Difference
Tax
Rate
December
31, 20x12
Book Value
314,913.81
December
31, 20x12
Tax Value
145,379.95
Temporary
Difference
Tax
Rate
0.4
FTA/L
Amount
20x11
61,857.07
154.642.67
265,248.75
153,667.68
122,850.00
December
31, 20x13
Book Value
275,549.59
December
31, 20x13
Tax Value
101,765.96
Temporary
Difference
Tax
Rate
0.4
FTA/L
Amount
20x12
67,813.55
173,783.62
0.4
FTA/L
Amou
20x14
69,51
169,533.86
111,581.08
0.4
44,632.43
229,178.75
107,567.37
121,611.38
0.4
48,644.55
210,268.02
75,297.16
134,970.86
0.4
53,98
64,974.00
57,876.00
0.4
23,150.40
107,550.00
45,481.80
62,068.20
0.4
24,827.28
97,595.00
31,837.26
65,757.74
0.4
26,30
12,682.50
10,252.80
2,429.70
0.4
971.88
10,902.50
8,202.24
2,700.26
0.4
1,080.10
9,812.25
6,561.79
3,250.46
0.4
1,300
5,500.00
-
5,500.00
0.4
2,200.00
3,740.00
-
3,740.00
0.4
1,496.00
2,805.00
-
2,805.00
0.4
1,122
720,620.83
719,824.90
795.94
0.4
318.37
694,054.17
691,031.90
3,022.27
0.4
1,208.91
678,630.74
525,088.85
663,390.62
477,997.50
15,240.12
47,091.35
0.4
0.4
6,096
18,83
619,
981.88
91,502.50
577,065.00
42,916.88
0.4
17,16
93,500.00
(1,997.50)
0.4
(799.0
133,130.1
5
145,070.3
9
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-8
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Case 16-2 Software Incorporated
Overview
This case involves a private company that is contemplating going public. They currently
are using accounting standards for private enterprises and if they go public would need to
switch to international accounting standards. This case includes a large number of issues.
SI has a bank loan with a covenant that requires a minimum current ratio. They have a
strong motivation to maintain this ratio. It is critical that recommendations are ethical and
not just made to meet this ratio. With taxable losses in the current year income
minimization is not a current objective.
Issues
1. Revenue recognition
2. Warranty
3. Accounting for income tax
4. Forward contract and shares
5. Asset retirement obligation
6. Convertible bonds
7. Stock options
Analysis and Conclusions
1. Revenue recognition
The earliest revenue can be recognized is when there is performance. The fee paid by the
customer includes the software and installation, monitoring and maintenance. This would
be considered a multiple deliverable. The fee would need to be split between the amount
related to the product software compared to the amount related to the services of
monitoring and maintenance.
Performance for the software and installation would be when it is delivered to the
customer and installed. There is still a risk related to payment since the fee is due 30 days
after installation. There is also a risk related to the warranty. For the portion of the fee
related to the software one alternative is to recognize revenue when the software is
installed and estimate bad debt and warranty expense. Since SI has been in business since
the 1990’s they have historical evidence on which to make estimates. A second
alternative is to recognize the revenue when the cash is received in 30 days. A third
alternative would be to delay revenue recognition until the warranty expires. I recommend
for the portion of the fee related to the software revenue be recognized when the software
is installed since this is when performance has occurred. There is historical evidence to be
able to estimate bad debt expense and warranty costs.
Performance for the service portion of the fee is over time as the service is provided over
three to five years. Assuming the service would be provided on an even basis revenue
should be recognized on a straight-line basis over the service period.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-9
If SI goes public the accounting for this issue would be similar.
2. Warranty
As mentioned above the warranty relates to the sale of the product. A warranty expense
and estimated warranty liability should be recognized when revenue for the software is
recognized. The liability decreases the current ratio, which is undesirable but necessary.
The estimated warranty liability for 20x9 is $12 million (8+5-1). This creates a temporary
difference. Since SI uses the taxes payable method of accounting for income taxes SI will
not recognize any deferred tax assets or liabilities. If SI goes public the liability method
would be required. The temporary difference for SI would then be recognized as a
deferred tax asset if it is probable SI will generate taxable income.
Factors to support that it is probable is theit history of earnings historically and they have
a new product that they are bringing to market with anticipated significant sales. Factors
that support it may not be probable are the large loss this year. I conclude that it would be
probable and the deferred tax asset would be recognized.
3. Accounting for income tax
SI is currently a private company and has elected to use the taxes payable method which
is an option in accounting standards for private enterprises. This option will no longer be
allowed if SI makes the decision to go public. They will be required to adopt the liability
method that will recognize deferred tax assets and liabilities.
SI has an anticipated taxable loss of $10 million in 20x9. They will carryback the loss for
the last three years and recognize an income tax receivable. The amount that they will
carryback will be $2 million in 20x6, $5 million in 20x7 and $1 million in 20x8. They
will recover the taxes they actually paid in those years which would be $2 million x
38%=$760,000; $5 million x 39%=$1,950,000; and $1 million x 40%=$400,000 for a
total of $3,110,000. There remains a taxable loss of $2 million which will be carried
forward and applied against future income taxes. If SI goes public this loss would then be
recognized as a deferred tax asset if it is probable SI will generate taxable income. The
factors to support if it is probable or not are the same as discussed above for the warranty.
4. Forward contract and shares
The forward contract is a derivative. SI will need to decide if they want to elect hedge
accounting or not. Since they often enter into hedging relationships it may be beneficial.
If SI does not elect hedge accounting the forward contract would be measured at fair
value every reporting date. The changes in value would impact net income. If they did
elect hedge accounting it would need to be determined if it was a critical match of key
terms. If yes there would be no impact on the financial statements until the hedge was
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-10
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
terminated. If SI went public and did not elect hedge accounting the derivative would be
classified in fair value through profit or loss. The forward contract would still be
measured at fair value every reporting date and the changes would impact net income. If
they elected hedge accounting this would be a cash flow hedge and it would be recorded
in OCI.
The shares would be a non-strategic investment. It must be determined if these shares are
quoted in an active market. If they are which is likely since they are a portfolio of
investments then the shares would be measured at fair value every reporting date and the
changes in value would impact net income. If the shares are for companies not traded in
an active market then they would be measured at cost or they could elect to use fair value.
If SI went public the shares would be recorded either in fair value through profit or loss or
in fair value through OCI. I am assuming that SI will decide to early adopt IFRS 9. In
both situations they would be recorded at fair value every reporting date. In fair value
through profit and loss the changes would impact net income. Or if in fair value through
OCI the changes would impact other comprehensive income. Since these investments are
traded on an active basis it is likely they would meet the criteria for held for trading and
be recorded in fair value through profit and loss.
5. Asset retirement obligation
The satellite towers would be recorded as an item of property, plant and equipment. The
regulatory obligation to dismantle the towers would be an asset retirement obligation.
This would be measured at the present value of $2.5 million using an appropriate
discount rate. The incremental borrowing rate of 10% would provide an asset retirement
obligation of $2.5 (10%,20 years)(.14864)=$371,600. The satellite towers would be
recorded at $15,371,600 and depreciated over 20 years. At the end of the first year
depreciation expense would be $768,580. The asset retirement obligation would be
recorded at $371,600 and accretion expense of $37,160 would be recognized at the end of
the year. If SI goes public the accounting for this issue would be similar. The asset
retirement obligation would be classified as a long term liability and would have no
impact on the current ratio.
6. Convertible bonds
The convertible bond is a hybrid instrument. In accounting standards for private
enterprises SI can assign a zero amount to the equity component. The convertible bond
would all be measured as debt. Or they could determine the fair value of the bond
assuming this is the most measurable component and record that as debt since the
company has to make the interest and principal payments. The remaining value would go
to the conversion rights since this amount never has to be paid back. The current portion
of the debt would have a negative impact on the current ratio. If SI went public in
international standards they would need to record the conversion rights at fair value using
the incremental method. The debt portion would be recorded at fair value and any
remaining amount would be allocated to the conversion rights.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-11
The fair value of the bond is using the incremental borrowing rate of 10%. Since semiannual payments use 20 payments and 5%:
15,000,000 (.37689) = 5,653,350
600,000 (12,46221) = 7,477,326
13,130,676
The bond would be recorded as follows:
Cash
14,800,000
Discount 1,869,324
Bond
15,000,000
Conversion Rights 1,669,324
7. Stock options
Stock option expense needs to be recorded using a fair value model. The Black Scholes
method would be considered an appropriate model. A decrease in the expected life of the
options would decrease the stock option expense since the time period in which to
exercise the options is less. A decrease in the stock price volatility would also decrease
stock option expense since it is likely the shares would be at a favourable price. A
decrease in the risk free interest rate will decrease stock option expense.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-12
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Case 16-3 Deep Harbour Limited
Assessment
Deep Harbour Limited (DHL) is a plastic molding company with a profitable past and a
strong equity position ($5.7 million on total assets of $17.4 million; 33%). They have
new CBC (bank) financing of $7 million this year, incurred to finance manufacturing
equipment. As a result, they must adopt the tax allocation accounting method for
corporate income tax and meet several ratio requirements. It is unclear if DHL is using
accounting standards for private enterprise or international accounting standards. This
must be clarified with the bank. I am assuming the bank requires international accounting
policies. An equally valid assumption is that the bank would allow accounting standards
for private enterprises to be used and the bank would specify which accounting policy
must be applied where there is a choice as there is in income taxes. The current ratio is
1.08 in the draft financial statements and must be at least 1. The total-debt-to-equity ratio
is 2.06 and must be less than 4. The current ratio is a concern, as DHL has no cash and
an operating line of credit.
Issues
1.
2.
3.
4.
5.
6.
Interest capitalization
Investment tax credit
Warranty
Depreciation method
Accounting for income tax
Current liquidity
Analysis and Conclusions
Before income tax accounting can be applied, accounting policies must be evaluated and
changed in other areas to provide a “clean” starting point.
1.
Interest capitalization
DHL has capitalized interest on the new machinery for the period during which it
was being installed. Interest is capitalized for qualifying assets that take a
substantial amount of time for completion. Otherwise, interest is an operating
cost, and is expensed as a period cost. The installation period was only a short
period of time therefore would not meet the criteria of a qualifying asset. It is
hard to see how this asset has enhanced future cash flow because of delays in
installation. Therefore, $35,000 of interest has been expensed. Amortization of
$3,500 on the capitalized amount has been eliminated.
On the financial statements, this reduces the value of capital assets (see Exhibit 1)
and reduces accounting income (Exhibit 2). Reconciliation items in the
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-13
calculation of taxable income change (Exhibit 3), but changes do not affect the
total taxable income.
2.
Investment tax credit
The investment tax credit (ITC) is assumed to be correctly calculated, at $1,200.
On the revised statement of financial position (Exhibit 2), the $1,200 receivable
has been offset to income tax otherwise payable (see tax entries, Exhibit 5).
As an offset to the cost of capital assets, the ITC may be credited directly to capital
assets or shown as a deferred credit. DHL has chosen the latter, which is
acceptable. However, to eliminate the deferred credit, which would be a liability in
the debt-to-equity ratio, the ITC has been netted with capital assets in Exhibit 1.
Furthermore, the ITC must be amortized over the same term as the capital assets
to which it relates; that is, ten years, not four. This means that 20X8 amortization
must be $120, not $300. The adjustment is $180 and the balance is $1,020.
On the financial statements, this decreases capital assets (Exhibit 1) and reduces
accounting income (Exhibit 2). It changes the starting point and reconciliation
items of taxable income, but not the total taxable income (Exhibit 3).
3.
Warranty
Accounting policies recognize a warranty liability when it is probable and
estimable. This allows the financial statements to report the financial position of
the company with greater integrity, and also promotes matching on the income
statement. These policies are appropriate and likely required to satisfy the
primary financial statement user, CBC. The liability decreases the current ratio,
which is undesirable but necessary.
Since a range has been given, the low value is recorded at $60,000. This reflects
concern that the current ratio remains over 1. Exhibit 1 reflects this liability as a
current liability. Accrual has decreased net income this year (Exhibit 2).
Retrospective application is not possible, as experience was not available at the
beginning of the year. Taxable income starts with the revised net income, but
now must be adjusted for the temporary difference. Again, the end result is no
change to taxable income.
4.
Depreciation method
DHL should consider its depreciation policies. Capital assets are material, and
thus depreciation will impact current earnings and net assets in significant terms.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-14
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Existing policies are acceptable and have not been changed. However, DHL
should consider their policy for:
(i)
Partial year amortization
A full year of depreciation is charged for assets purchased halfway through
the year. DHL has recorded $820,000 of depreciation on assets used only
for April to November (nine months). Half-year or exact proration could
be considered.
(ii)
Components
DHL must determine if any machinery have significant components. If
there are then each component should be depreciated separately. Without
further information we will assume there are no significant components.
(iii)
Estimates of useful life
DHL should carefully review estimates of useful life on an annual basis.
Longer lives would lower depreciation and increase net assets; shorter
lives would have the opposite effect.
5.
Accounting for income tax
Using the liability method, deferred income tax is established in all cases where
the tax basis of assets is different than the accounting basis. DHL has three such
differences:
(i)
Inventory
The write-down to LCM is recorded for accounting purposes, but not for
tax. It is tax-deductible only when the inventory is sold. The accounting
carrying value, after write-down, is $513, but the tax basis is $40 higher, at
$553. This creates a deferred tax asset of $16.8. (See Exhibit 4.)
(ii)
Capital assets
Accounting carrying value is $11,738.5, after the capitalized interest and
ITC are removed (see Exhibit 1) . The tax basis, after the ITC, is given at
$9,100. More CCA has been charged to date than depreciation, creating a
deferred tax liability of $1,108.2 (see Exhibit 4).
(iii)
Warranty
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-15
The warranty liability is $60,000 on the revised statement of financial
position, but the tax basis is zero as the warranty expense is not claimed
for tax purposes until cash is paid. This creates a deferred tax asset of
$25.2 (see Exhibit 4).
The deferred tax liability caused by the capital assets is a long-term liability. The
deferred tax assets caused by current inventory and warranty are both long-term
assets, classified as one element in Exhibit 1.
To adjust DHL’s financial statements to the liability method, deferred income tax
amounts are combined with income tax payable to record the expense. Note that
some of this expense would impact prior years, but this breakdown has not been
requested by DHL at this time. The entry to record tax is shown in Exhibit 5, and
the deferred income tax amounts are reflected on the statement of financial
position in Exhibit 1. Note that taxable income (Exhibit 3) did not change as a
result of adjustments.
The adjustments in Exhibit 5 also show application of the ITC to the current year
payable, and consideration of the $120 of current year installment payments. A
refund of $84 can be claimed because installment payments were too high.
Note the large decrease to shareholders’ equity caused by:
6.
(i)
The current tax on 20X8 income, not recorded in the draft financial
statements.
(ii)
The large net deferred income tax liabilities, now recorded.
Current liquidity
Revised financial statements show a current ratio of .99 or close to one and a debtto-equity ratio of 3.84. The covenant for the current ratio is just below the
allowable limit of 1 and the debt to equity ratio is met, but not with any margin for
comfort. DHL would be well advised to review its current position. Accounts
receivable are high, as are accounts payable. Both should be reduced, beginning
with collections from customers, to provide some liquidity. DHL could also
consider increasing long-term debt, using capital assets as collateral, to improve
the current position. If the bank allows accounting standards for private
enterprises the current ratio would not be violated since the deferred tax asset
would be classified as a current asset not long-term.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-16
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
EXHIBIT 1
DHL—REVISED STATEMENT OF FINANCIAL POSITION
as of 30 November 20X8
(in thousands)
Assets
Current
Accounts receivable .....................................................................
Inventory, at lower of cost or market ...........................................
Prepaid expenses ($219 – $120) ..................................................
Investment tax credit receivable ($1,200 – $1,200) .....................
Income tax refund receivable ($84) .............................................
$ 2,690.0
513.0
99.0
0.0
84.0
3,386.0
42.0
11,738.5
$15,166.5
Deferred income tax ($16.8 + $25.2) .......................................................
Capital assets, net of depreciation ($12,850 – $35 + $3.5) – $1,080)......
Liabilities
Current liabilities:
Bank operating line of credit .......................................................
Accounts payable and accrued liabilities .....................................
Deferred ITC ($900 – $900) ........................................................
Warranty payable ($60) ................................................................
$
295.0
3,071.0
0.0
60.0
3,426.0
7,500.0
1,108.2
12,034.2
3,132.3
$15,166.5
Long-term debt ...................................................................................
Deferred income tax ($1,108.2) ...............................................................
Total liabilities ........................................................................................
Shareholders’ equity ($5,706 – $271.5 (Exhibit 2) – $2,302.2) ..............
EXHIBIT 2
DHL—REVISED ACCOUNTING INCOME
(in thousands)
Accounting income, as previously reported ................................
Less: Additional interest expense ............................................
Amortization eliminated .................................................
ITC amortization change .................................................
Warranty accrual .............................................................
Revised net income ....................................................................
$ 2,252.0
(35.0)
3.5
(31.5)
(180.0)
(60.0)
$ 1,980.5
Net income has been reduced by $271.5 ($1,980.5 – $2,252)
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-17
EXHIBIT 3
DHL - REVISED TAXABLE INCOME
Accounting income (Exhibit 2) ..........................................................
Depreciation ($1,306 – $3.5) .................................................
Capital cost allowance ...........................................................
Inventory write-down to LCM ...............................................
Interest capitalized ($35 – $35) (1) ........................................
Non-deductible entertainment and marketing expenses ........
Amortization of deferred investment tax credit .....................
Warranty accrual ....................................................................
Taxable income unchanged ................................................................
Income tax payable (@42%) ..............................................................
(1) Allowable tax expense now on the income statement.
$ 1,980.5
1,302.5
(404.0)
40.0
0.0
84.0
(120.0)
60.0
$ 2,943.0
$ 1,236.0
EXHIBIT 4
DHL - DEFERRED INCOME TAX BALANCES
(in thousands)
Tax
Basis
Inventory
Capital
Assets
Warranty
1
2
553 1
9,100
0
Accounting
Basis
513
11,738.5 2
(60)
Diff.
Deferred
Income
Tax @ .42
40
16.8
(2,638.5)
(1,108.2)
60
25.2
Opening
Balance
Adjustment
0
0
16.8
(1,108.2)
0
25.2
$513 + $40
See Exhibit 1
EXHIBIT 5
DHL—INCOME TAX ENTRIES, 20X8
Deferred income tax – inventory............................................
Deferred income tax – warranty ............................................
Retained earnings ...................................................................
Deferred income tax – capital assets ................................
Income tax payable (Exhibit 3) ........................................
16.8
25.2
2,302.2
Income tax payable ................................................................
Investment tax credit receivable ......................................
1,200
Income tax receivable ...........................................................
Income tax payable ................................................................
Prepaid expenses ..............................................................
84
36
1,108.2
1,236.0
1,200
120
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-18
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Technical Review
Technical Review 16-1
Requirement 1
Golf club dues – add back $20,000 since expense on income statement but not allowed
deduction for income taxes.
Depreciation expense – add back $60,000 since expense on income statement but not
allowed deduction for income taxes.
Development costs – deduct $100,000 since capitalized. The costs incurred this year are
deductible for income taxes.
Warranty costs accrued – add back accrued costs 30,000 since expense on income
statement but not allowed deduction for income taxes.
Interest and penalty – add back $25,000 since expense on income statement but not
allowed deduction for income taxes.
CCA – subtract $180,000 since this amount is an allowable tax deduction and has not
been included on income statement.
Amortization development costs – add back $10,000 since expense on income statement
but not allowed deduction for income taxes.
Costs incurred warranty – subtract $22,000 since costs incurred for warranty work this
year are deductible for income taxes.
Requirement 2
Golf club dues – permanent difference
Depreciation expense – temporary difference
Development costs – temporary difference
Warranty costs accrued – temporary difference
Interest and penalty – permanent difference
CCA – temporary difference
Amortization development costs – temporary difference
Costs incurred warranty – temporary difference
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-19
Technical Review 16-2
Requirement 1
Net income ...................................................................2,200,000
Add: Golf club dues ..........................................................20,000
Depreciation expense ...............................................60,000
Accrued warranty costs ...........................................30,000
Interest and penalties ................................................25,000
Amortization ............................................................10,000
Subtract: CCA .................................................................180,000
Costs incurred development ............................100,000
Costs incurred warranty ....................................22,000
Taxable income ............................................................2,043,000
Requirement 2
Income tax payable 2,043,000 x 40% = $817,200.
Technical Review 16-3
a.
b.
c.
d.
e.
f.
credit
debit
credit
credit
debit
debit
Technical Review 16-4
Requirement 1
Depreciation vs. CCA - $120,000 x 40% = $48,000 deferred tax liability
Warranty costs - $8,000 x 40% = $3,200 deferred tax asset
Development costs - $90,000 x 40% = $36,000 deferred tax liability
Requirement 2
Income tax expense
898,000
Deferred tax asset
3,200
Deferred tax liability
Deferred tax liability
Income tax payable
48,000
36,000
817,200
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-20
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Technical Review 16-5
Tax basis
Accounting basis
Temporary difference
Deferred income tax expense
Deferred income tax balance
20X6
$1,080,000
$960,000
$120,000
$40,800 cr.
$40,800 dr.
20X7
$864,000
$720,000
$144,000
$8,160 cr.
$48,960 dr.
20X8
$689,000
$480,000
$209,000
$22,100 cr.
$71,060 dr.
Assignments
Assignment 16-1
Requirement 1
Tax expense:
20x8
20x9
$ 182,400
456,000
$ 638,400
($480,000 × .38)
($1,200,000 × .38)
This measurement of tax expense is potentially misleading because of its poor correlation
with accounting income. The implied tax rate is 22.8% ($182,400/$800,000) in 20x8 and
51.8% ($456,000/$880,000) in 20x9.
Requirement 2
Tax expense:
20x8
20x9
$ 304,000
334,400
$ 638,400
Deferred income tax:
($800,000 × .38)
($880,000 × .38)
$121,600 cr. increase; $121,600 cr. balance
$121,600 debit decrease; $0 balance
Total expense is the same because the $304,000 temporary difference between accounting
and taxable income has reversed over the two-year time frame.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-21
Assignment 16-2
Development Costs
Tax basis
Accounting basis
Temporary difference
Deferred income tax balance
Asset or Liability
20X6
$
0
$90,000
$(90,000)
$36,000
Liability
20X7
$
0
$172,000
$(172,000)
$65,360
Liability
20X6
20X7
$
0
$ 5,000
$ 5,000
$ 2,000
Asset
$
0
$ 10,000
$ 10,000
$ 3,800
Asset
20X8
0
$254,000
$(254,000)
$96,520
Liability
20X9
$
0
$254,000
$(254,000)
$91,440
Liability
20X8
20X9
$
Warranty Costs
Tax basis
Accounting basis
Temporary difference
Deferred income tax balance
Asset or Liability
$
$
$
$
0
5,000
5,000
1,900
Asset
$
0
$ 30,000
$ 30,000
$ 10,800
Asset
Assignment 16-3
20X8
20X9
$600,000
20,000
620,000
248,000
372,000
–
$500,000
–
500,000
200,000
300,000
26,400
$372,000
$326,400
20x5
$124,000
(92,000)
(10,000)
22,000
20x6
$144,000
(95,000)
(10,000)
39,000
20x7
$164,000
(128,000)
(10,000)
26,000
10,000
(12,000)
(2,000)
$ 20,000
10,000
(8,000)
2,000
$ 41,000
10,000
(4,000)
6,000
$ 32,000
Income from continuing operations, before unusual item,
discontinued operation, and income tax
Gain on sale of capital assets
Income before income tax
Income tax expense
Income from continuing operations
Gain from discontinued operations—net of $17,600 income
tax
Net income
Assignment 16-4 (WEB)
20x4
Revenues ...................................... $110,000
Expenses ...................................... (80,000)
Depreciation, straight line ............ (10,000)
Pretax accounting income (given)
20,000
Temporary differences for depreciation:
Add accounting depreciation
expense.................................
10,000
Less capital cost allowance .... (16,000)
Net temporary difference .............
(6,000)
Taxable income ............................ $ 14,000
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-22
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Computation of income tax payable:
Taxable income ............................ $ 14,000
Income tax rate .............................
× .40
Income tax payable ...................... $ 5,600
Deferred income tax, balance sheet
Net temporary differences (see req 1) (6,000)
Tax rate ...........................................
.40
Change in period ............................. (2,400)
Cumulative balance in DIT ......... (2,400) cr.
$ 20,000
× .40
$ 8,000
(2,000)
.40
(800)
(3,200) cr.
$ 41,000
× .40
$ 16,400
2,000
.40
800
(2,400) cr.
$ 32,000
× .40
$ 12,800
6,000
.40
2,400
____0
A table can also be used for calculations:
Tax Carrying
Temp Deferred Op. Bal. Adjustment
(in 000's) Basis
Value
Diff
Tax
20x4 40%
Cap.Assets
$ 24
$ 30
$(6) $ (2.4)
0
$ (2.4)
20x5 40%
Cap.Assets
12
20
(8)
(3.2)
(2.4)
(.8)
20x6 40%
Cap.Assets
4
10
(6)
(2.4)
(3.2)
.8
20x7 40%
Cap.Assets
0
0
0
0
(2.4)
2.4
Income tax expense, liability method of tax allocation:
20x4
20x5
Income tax expense:
Income tax payable ......................
$5,600
$8,000
Temporary differences .................
2,400
800
$8,000
$8,800
20x6
20x7
$16,400
(800)
$15,600
$12,800
(2,400)
$10,400
Net income, liability method of tax allocation
20x4
Pre-tax .......................................... $20,000
Income tax expense ......................
8,000
$12,000
20x6
$39,000
15,600
$23,400
20x7
$26,000
10,400
$15,600
20x5
$22,000
8,800
$13,200
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-23
Assignment 16-5
Requirements 1 and 2
The depreciation pattern for each asset is as follows:
Year
1
2
3
Book
1/3
1/3
1/3
Tax
1/2
1/3
1/6
For the asset acquired in 20X5, the book-tax depreciation and DIT balance is:
Year
Book
depreciation
Tax
CCA
20X5
20X6
20X7
$60,000
60,000
60,000
$90,000
60,000
30,000
TD
originating
(reversing)
$30,000
0
(30,000)
Accumulated
TD balance
DIT liab.
@40%
$30,000
30,000
0
$12,000
12,000
0
The cost of new equipment goes up to $192,000 in 20X6 and $198,000 in 20X7.
Therefore, the amount of the TD will rise proportionately for each year’s additional
acquisition. The lapsing schedule for the temporary differences will appear as follows:
Year of asset acquisition
20X5
20X6
20X7
Requirement 1: TDs, end of year
Requirement 2: DIT liability @ 40%
Cumulative balances
20X5
20X6
20X7
$30,000
$30,000
0
32,000
$32,000
33,000
$30,000
$62,000
$65,000
$ 12,000
$ 24,800
$ 26,000
Requirement 3
If McQuinn maintains the 20X7 level of investment in equipment (in dollar terms), the
temporary differences will never reverse and therefore the DIT liability will not be drawn
down it will just continue to increase.
Requirement 4
In order for the accumulated timing difference to fall, the monetary investment in these
assets must decline. This can happen either because (1) prices are falling, permitting
maintenance of productive capacity with a lower monetary investment, or (2) McQuinn
ceases to replace assets.
Requirement 5
A reversal will cause a cash outflow (through higher taxes) only if the company has
taxable income during the period during which the reversals occur.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-24
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Assignment 16-6
Requirements 1 and 3
Requirement 3
31 December 20X8:
Equipment
Development costs
Total
31 December 20X9:
Equipment
Development costs
Total
Requirement 1
Temporary
difference
Accounting basis
Tax basis
$2,400,000
600,000
$3,000,000
$1,100,000
0
$1,100,000
$1,300,000
600,000
$1,900,000
Accounting basis
Tax basis
Temporary
difference
$1,470,000††
0
$1,470,000
$ 945,000
500,000
$1,445,000
$2,415,000†
500,000
$2,915,000
† Asset balance, Y/E 20X9 ($4,000,000 + $600,000 – $250,000)
$4,350,000
Accumulated depreciation:
Beginning balance ($4,000,000 × 40%)
$1,600,000
Less depreciation on retired equipment ($250,000 × 40%) (100,000)
20X9 depreciation
($4,000,000 + $600,000 – $250,000) × 10%
435,000* 1,935,000
Accounting basis
$2,415,000
* Assuming full 1st-year convention, based on 40% depreciation (i.e., 10% × 4) at Y/E
20X8. Other assumptions could be used.
††Tax basis
UCC beginning of 20X8
$1,100,000
Assets acquired
600,000
Assets retired (assuming no residual value, there is no net effect on UCC)
—
20X9 CCA = [($1,100,000 – $250,000) × 20%] + [$600,000 × 10%]
(230,000)
Tax basis, Y/E 20X9
$1,470,000
Requirement 2
Deferred income tax balance (long term):
Year-end 20X8: $1,900,000 × 38% = $722,000 credit balance
Year-end 20X9: $1,445,000 × 38% = $549,100 credit balance
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-25
Requirement 4
The balance is decreasing in 20X9 because most of the existing CCA tax shield has
already been used, which suggests that the $4,000,000 in equipment probably was all
acquired at the same time. However, if Carter now maintains a policy of continuous
equipment reinvestment and renewal, CCA again become greater than accounting
amortization, causing an increase in the temporary difference and an increase in future
income tax. The dollar volume of assets in the early stages of CCA will offset the volume
in the later stages, thereby stabilizing the balance of temporary differences. The balance
will decline again only when Carter slows its investment in new assets, due either to nonrenewal or to declining prices for replacement equipment.
Assignment 16-7
20x9
Income tax payable:
Accounting income subject to tax ........................................ $980,000
Permanent difference:
Golf club dues .................................................................. _25,000
Accounting income subject to tax ........................................ 1,005,000
Temporary differences:
Warranty costs accrued ....................................................
80,000
Warranty costs incurred ................................................... (65,000)
Depreciation ..................................................................... 125,000
CCA ................................................................................. (250,000)
Taxable income ................................................................ $895,000
Income tax payable (at 36%) ................................................ $ 322,200
Deferred income tax:
Tax Accounting
Basis
Basis
20x9
Capital assets1,000,000 $1,125,000
Warranty
0
(15,000)
Temporary Deferred tax Opening Adjustment
Difference
Balance
($125,000) ($45,000)
15,000
5,400
Income tax expense ................................................
Deferred income tax ...............................................
Deferred income tax ..................................
Income tax payable ...................................
0
0
($45,000)
5,400
361,800
5,400
45,000
322,200
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-26
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Assignment 16-8
Requirement 1
a. Permanent difference, $20,000. The expense will never be tax deductible.
b. Permanent difference, $680,000. Revenue will never be taxable.
c. Temporary difference, $140,000. The temporary difference will reverse as
warranty costs are incurred.
d. Capital gain of $480,000 total: 50% temporary difference, $240,000; and 50%
permanent difference, $240,000. The temporary difference will reverse in 20X10.
e. Temporary difference, $100,000. The temporary difference will reverse as
development costs are depreciated.
f. Temporary difference of $100,000. The temporary difference will reverse for
individual asset as it is depreciated.
Requirement 2
Income tax expense (6) ..........................................
Deferred income tax (3) .........................................
Deferred income tax (2) .............................
Deferred income tax (4) .............................
Deferred income tax (5) .............................
Income tax payable (1) ...............................
(1) Accounting income
Permanent differences:
Golf club dues
Investment income
Gain on land
Accounting income subject to tax
Temporary differences:
Gain on land disposal
Estimated warranty expense
Development costs incurred
Depreciation
CCA
Taxable income
Income tax payable (38%)
(2)
(3)
(4)
(5)
(6)
581,400
53,200
91,200
38,000
38,000
467,400
$ 2,400,000
20,000
(650,000)
(240,000)
1,530,000
(240,000)
140,000
(100,000)
200,000
(300,000)
$ 1,230,000
$ 467,400
($240,000) × .38 = $91,200 Cr.
$140,000 × .38 = $53,200 Dr.
($100,000) x .38 = $38,000 Cr.
$200,000 – ($300,000) = ($100,000) x .38 = $38,000 Cr.
$91,200 + $38,000 + $38,000 + $467,400– $53,200 = $581,400 Dr.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-27
Requirement 3
Statement of Financial Position
Non-current assets
Deferred tax asset .................................
Current liability
Income tax payable ..............................
Non-current liabilities
Deferred tax liability ............................
Statement of profit and loss
Income tax expense – current ...............
– deferred .............
Total income tax expense.....................
$53,200
$467,400
$167,200
$ 467,400
114,000
$581,400
Assignment 16-9
Requirement 1
This is a temporary difference because the rent revenue is reported for accounting
purposes in 20x6 and 20x7, but the full amount is included in 20x6 as taxable income.
The $4,800 amount ($800 per month × 6 months) is an adjustment that will reverse in
20x7, and gives rise to a debit in deferred income tax asset.
Requirement 2
At the end of 20x6, the accounting basis for unearned rent is $2,400. The tax basis is
zero; $2,400 less $2,400 to be taxable in future periods.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-28
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Requirement 3
20x6:
Pre-tax accounting income ..................................................... $450,000
Temporary differences:
Advance collection of rent .............................................
2,400
Taxable income ...................................................................... 452,400
Tax rate ..................................................................................
× .40
Income tax payable ................................................................ $180,960
Deferred income tax debit, 31 December 20x6 ($2,400 × .4)
$960
Computation of income tax expense:
Income tax payable ........................................................ $180,960
Increase in deferred income tax debit ............................
(960)
Income tax expense in 20x6 ........................................... $180,000
The journal entry to record income tax for 20x6 is:
Income tax expense ................................................................ 180,000
Deferred income tax ...............................................................
960
Income tax payable ........................................................
180,960
20x7:
Pre-tax accounting income .....................................................
Temporary differences:
Advance collection of rent .............................................
Taxable income ......................................................................
Tax rate ..................................................................................
Income tax payable ................................................................
Deferred income tax debit, 31 December 20x7 .....................
Computation of income tax expense:
Income tax payable ........................................................
(Increase) decrease in deferred income tax debit ...........
Income tax expense in 20x7 ...........................................
$38,000
(2,400)
35,600
× .40
$14,240
$0
$14,240
960
$15,200
The journal entry to record income tax for 20x7 is:
Income tax expense .........................................................................
Deferred income tax ................................................................
Income tax payable ..................................................................
15,200
960
14,240
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-29
Requirement 4
Partial statement of profit and loss
Accounting income before income tax ......................................
Income tax expense – current ...................................................
– non-current ............................................
Net income .................................................................................
20x6
20x7
$450,000
180,960
(960)
180,000
$270,000
$38,000
14,240
960
15,200
$22,800
20x6
20x7
Requirement 5
Statement of Financial Position:
Non-current assets
Deferred income tax .....................................................
$960
0
Assignment 16-10
Requirement 1
Unearned rent Warranty
Accounting carrying value, 20x8 (both liabilities) ............... $90,000
$52,000
Tax basis, 20x8 ....................................................................
0
0
Accounting and tax basis for both would be zero at the end of 20x9.
Requirement 2
20x8
Income tax payable:
Accounting income subject to tax ........................................ $210,000
Permanent difference:
membership dues ............................................................. _ _ ____
Accounting income subject to tax ........................................ 210,000
Temporary differences:
Unearned rent revenue .....................................................
90,000
Warranty expense .............................................................
52,000
Taxable income..................................................................... $352,000
Income tax payable (at 40%) ................................................ $140,800
20x9
$230,000
30,000
260,000
(90,000)
(52,000)
$118,000
$ 47,200
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-30
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Deferred income tax:
Tax Accounting
Basis
Basis
20x8
Unearned revenue
Warranty
20x9
Unearned revenue
Warranty
0
0
0
0
($90,000)
(52,000)
Temporary Deferred
Difference
tax
Opening Adjustment
Balance
$90,000
52,000
$36,000
20,800
0
0
0
0
0
0
36,000
20,800
0
0
Income tax expense:
Income tax payable ............................................................... $140,800
Deferred income tax:
Related to rent revenue ($90,000 × 40%) ........................ (36,000)
Related to warranty ($52,000 × 40%) .............................. ( 20,800)
Income tax expense............................................................... $84,000
$36,000
20,800
(36,000)
(20,800)
$47,200
36,000
20,800
$104,000
Requirement 3
20x8
Income tax expense .........................
Deferred income tax ……...............
Income tax payable......................
20x9
84,000
56,800
104,000
56,800
47,200
140,800
Requirement 4
Statement of Profit and Loss:
20x8
Revenues ............................................................................... $660,000
Expenses ............................................................................... 460,000
Income before tax ................................................................. 210,000
Less: income tax expense (current portion, $140,800 in
20x8 and $47,200 in 20x9) .............................................
84,000
Net income ............................................................................ $ 126,000
20x9
$820,000
590,000
230,000
104,000
$ 126,000
Requirement 5
Statement of Financial Position
Non-current asset:
Deferred income tax asset ................................................
20x8
56,800
20x9
None
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-31
Assignment 16-11
Tax calculations:
Accounting income before income tax ..................
Temporary difference:
Revenue recognized ...................................
Cash received .............................................
Taxable income ......................................................
Tax rate ......................................................
Current income tax ................................................
20x1
$800,000
20x2
$980,000
(120,000) (420,000)
–
80,000
680,000
640,000
38%
38%
$258,400 $243,200
20x3
$660,000
–
190,000
850,000
40%
$340,000
Deferred income tax:
Tax Accounting
Basis
Basis
20x1
Account receivable
20x2
Account receivable
20x3
Account receivable
Temporary Deferred
Difference
tax
Opening Adjustment
Balance
0
$120,000
($120,000) ($45,600)
0
0
460,000
(460,000)1 (174,800)
0
270,000
(270,000) (108,000) (174,800)
(45,600)
($45,600)
(129,200)
66,800
1120,000 +420,000-80,000 = 460,000
Journal entry for 20x1
Income tax expense ..........................................................
Deferred income tax liability ...............................
Income tax payable ..............................................
Journal entry for 20x2
Income tax expense ..........................................................
Deferred income tax liability ...............................
Income tax payable ..............................................
Journal entry for 20x3
Income tax expense ..........................................................
Deferred income tax liability ...........................................
Income tax payable ..............................................
304,000
45,600
258,400
372,400
129,200
243,200
273,200
66,800
340,000
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-32
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Assignment 16-12
Tax calculations:
Accounting income before income tax ......................
Add permanent difference – golf club dues ...............
Accounting income subject to tax ..............................
Temporary differences:
Accrued warranty costs ..................................
Warranty costs................................................
Depreciation expense .....................................
CCA ...............................................................
Taxable income ..........................................................
Tax rate ..........................................................
Current income tax ....................................................
Tax Accounting
Basis
Basis
20x8
Capital asset 1,700,000
Warranty
0
20x9
Capital asset 1,450,000
Warranty
0
Temporary Deferred
Difference
tax
1,800,000
(10,000)
(100,000)
10,000
(40,000)
4,000
1,600,000
(40,000)
(150,000)
40,000
(57,000)
15,200
Journal entry for 20x8
Income tax expense ....................................................
Deferred income tax asset ..........................................
Deferred income tax liability .........................
Income tax payable ........................................
Journal entry for 20x9
Income tax expense ....................................................
Deferred income tax asset ..........................................
Deferred income tax liability .........................
Income tax payable ........................................
20x8
$ 550,000
10,000
560,000
20x9
$ 820,000
12,000
832,000
50,000
(40,000)
200,000
(300,000)
$ 470,000
40%
$ 188,000
120,000
(90,000)
200,000
(250,000)
$ 812,000
38%
$ 308,560
Opening Adjustment
Balance
0
0
(40,000)
4,000
(40,000)
4,000
(17,000)
11,200
224,000
4,000
40,000
188,000
314,360
11,200
17,000
308,560
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-33
Assignment 16-13 (WEB)
Income tax payable:
20x4
Accounting income .............................................. $550,000
Temporary difference ........................................... (300,000)
Taxable income .................................................... 250,000
Tax rate ................................................................
.30
Income tax payable .............................................. $75,000
20x5
$123,000
150,000
273,000
.35
$95,550
20x6
$310,000
150,000
460,000
.42
$193,200
20x5
$95,550
20x6
$193,200
(37,500)
$58,050
(52,500)
$140,700
Income tax expense:
20x4
$75,000
Income tax payable (above) .................................
Change in deferred income tax
See calculations, below ..................................
90,000
Income tax expense .............................................. $165,000
Deferred income tax liability balance .................. $ 90,000 cr.
$52,500 cr.
None
Deferred income tax:
Tax Accounting
Basis
Basis
20x4
Accounts receivable 0
20x5
Accounts receivable 0
20x6
Accounts receivable 0
$300,000
150,000
0
Temporary Deferred
Difference
Tax
($300,000) ($90,000)
(150,000)
0
(52,500)
0
Opening Adjustment
Balance
0
($90,000)
(90,000)
37,500
(52,500)
52,500
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-34
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Assignment 16-14 (WEB)
Requirement 1
This is a temporary difference because (a) pretax accounting income and taxable income
are different for each year, and (b) the difference will reverse in subsequent years.
Requirement 2
20x4
$90,000
72,000
Accounting net book value
Tax basis (UCC)
20x5
$60,000
36,000
20x6
$30,000
12,000
20x7
$0
0
Requirement 3
Accounting and taxable income 20x4 through 20x7:
20x4
20x5
20x6
20x7
Pretax income (excluding depreciation) ..... $60,000
$80,000
$70,000 $70,000
Depreciation ................................................ 30,000
30,000
30,000
30,000
Income before tax........................................ 30,000
50,000
40,000
40,000
Add back depreciation ................................ 30,000
30,000
30,000
30,000
Deduct depreciation for tax purposes (given):
20x4 ........................................................ $(48,000)
20x5 ........................................................
$(36,000)
20x6 ........................................................
$(24,000)
20x7 ........................................................ _____
_____
_____ $(12,000)
Taxable income ........................................... 12,000
44,000
46,000
58,000
Tax rate .......................................................
30%
30%
40%
40%
Income tax payable ..................................... $ 3,600
$13,200
$18,400 $23,200
Income tax expense:
Income tax payable ................................. $ 3,600
Change in deferred income tax ...............
5,400
Income tax expense ................................ $9,000
Tax Accounting
Basis
Basis
20x4
Capital asset
20x5
Capital asset
20x6
Capital asset
20x7
Capital asset
$13,200
1,800
$15,000
Temporary Deferred
Difference
Tax
$90,000
$(18,000)
$36,000
$60,000
(24,000)
(7,200) $(5,400)
$12,000
$30,000
(18,000)
(7,200)
0
0
0
$23,200
(7,200)
$16,000
Opening Adjustment
Balance
$72,000
0
$(5,400)
$18,400
0
$18,400
$0
$(5,400)
(1,800)
(7,200)
0
(7,200)
7,200
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-35
Journal entries
Income tax expense
Deferred income tax
Income tax payable
20x4
20x5
20x6
20x7
9,000
15,000
18,400
16,000
5,400
1,800
-- 7,200
3,600
13,200
18,400
23,200
Statement of Financial Position
Long-term liabilities:
Deferred income tax liability$5,400
$7,200
$7,200
None
Assignment 16-15
Requirement 1
20x7
Accounts receivable
Accounting basis (accounts receivable per books) ............... $800,000
Tax basis ...............................................................................
0
Warranty liability
Accounting basis (20x8 expense of $220,000, paid in 20x9)
0
Tax basis ...............................................................................
0
The income tax rate at 31 December 20x7 was 40% ($320,000/$800,000)
Requirement 2
Pretax accounting income ..............................................................................
Temporary differences:
Revenue collected ...................................................................................
Warranty expenses ..................................................................................
Taxable income ..............................................................................................
Tax rate ..........................................................................................................
Income tax payable ........................................................................................
Income tax expense:
Income tax payable ........................................................................................
Change in deferred tax:
Accounts receivable ................................................................................
Warranty liability ....................................................................................
Income tax expense ........................................................................................
20x8
$200,000
0
$220,000
0
20x8
$980,000
600,000
220,000
1,800,000
× .38
$684,000
$684,000
(244,000)
(83,600)
$356,400
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-36
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Tax Accounting
Basis
Basis
20x8
Accounts receivable
Warranty
0
0
200,000
(220,000)
Temporary Deferred tax Opening Adjustment
Difference (Liab)/Asset Balance
@38%
(given)
(200,000)
220,000
(76,000) (320,000) 244,000
83,600
0
83,600
The journal entry to record income tax for 20x8 is:
Income tax expense ......................................................................... 356,400
Deferred income tax liability—receivable ....................................... 244,000
Deferred income tax asset—warranty ............................................. 83,600
Income tax payable ...................................................................
684,000
Requirement 3
Deferred income tax asset ................................................................
Deferred income tax liability ...........................................................
$83,600
$76,000
Assignment 16-16
Calculation of taxable income/tax payable
Accounting income ............................................................
Non-deductible expenses ...................................................
Dividend revenue ...............................................................
Depreciation .......................................................................
CCA ...................................................................................
Warranty expense ...............................................................
Warranty claims paid .........................................................
Taxable income ..................................................................
Tax payable (41%) .............................................................
$170,000
42,000
(12,000)
75,000
(99,000)
39,000
(51,000)
$164,000
$ 67,240
DIT Table (in thousands)
Capital
assets
Warranty
1
2
3
Tax
Basis
Carrying
Value
Temp.
Diff.
Deferred
tax
Opening
Balance
Adjustment
$1,351 1
$1,675 2
$(324)
$(132.84)
$(120)
$(12.840)
0
(28) 3
28
11.480
16
(4.520)
$1,450 – $99
$1,750 – $75
$40 + $39 – $51
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-37
Entry
Tax expense .............................................................................
Deferred income tax—Warranty ............................................
Deferred income tax —Capital assets ....................................
Tax payable ............................................................................
84,600
4,520
12,840
67,240
Assignment 16-17
Requirement 1
Calculation of taxable income/tax payable
Accounting income ............................................................ $2,200,000
Non-deductible expense penalties......................................
50,000
Depreciation .......................................................................
750,000
CCA ...................................................................................
(550,000)
Warranty expense ...............................................................
180,000
Warranty claims paid .........................................................
(130,000)
Taxable income .................................................................. $2,500,000
Tax payable (40%) ............................................................. $ 1,000,000
DIT Table (in thousands)
Capital
assets
Warranty
Dev costs
1
2
3
4
Tax
Basis
Carrying
Value
Temp.
Diff.
Deferred
tax
Opening
Balance
Adjustment
$1,410 1
$2,410 2
$(1,000)
$(400)
$(304)
$(96)
100
(800)
40
(320)
19
(456)
21
136
0
0
(100) 3
800 4
$1,960 – $550
$2,760 – $350
$50 + $180 – $130
$1,200 - $400
Tax expense .............................................................................
Deferred income tax asset - Warranty......................................
Deferred income tax liability – Development costs .................
Deferred income tax —Capital assets ....................................
Tax payable ............................................................................
939,000
21,000
136,000
96,000
1,000,000
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-38
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Requirement 2
a. Deferred income tax asset
b. Deferred income tax liability
c. Estimated warranty liability
d. Capital assets (NBV)
e. Development costs
f. Capital assets (UCC)
$ 40,000
720,000
100,000
2,410,000
800,000
1,410,000
Assignment 16-18
Requirement 1
The golf club dues are a permanent difference because they are not tax deductible and
therefore will never reverse. The rent revenue and warranty costs are temporary
differences because both will be reported on the income statements and tax return,
although in different periods.
Requirement 2
a)
Income tax payable:
Pretax income before permanent and timing differences ........
Add permanent difference (not tax deductible) ..................
Accounting income subject to tax ...........................................
Timing differences:
Rent revenue collected in advance ......................................
Warranty costs.....................................................................
Taxable income (given) ...........................................................
Computation of income tax payable:
Income tax rate ........................................................................
Income tax payable ..................................................................
20x8
$76,000
40,000
116,000
20x9
$112,000
40,000
152,000
40,000
32,000
188,000
(40,000)
_ ____
112,000
× .38
$71,440
× .40
$44,800
Requirement 3
20x8
Income tax expense:
Current income tax expense .................................................... $71,440
Deferred income tax expense................................................... (27,360)
$44,080
Balance in deferred income tax:
Non-current .........................................................................
27,360 dr
20x9
$ 44,800
14,560
$59,360
12,800 dr
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-39
Tax Accounting
Basis
Basis
20x8 – 38%
Rent
0 ($40,000)
Warranty
0 ( 32,000)
20x8 Y/E Balance
20x9 – 40%
Rent drawdown
0
Rate adj.–warranty
0
20x9 Y/E balance
0
(32,000)
Temporary Deferred tax Opening Adjustment
Difference (Liab)/Asset Balance
Dr.(Cr.)
$40,000
32,000
$15,200
12,160
0
0
0
32,000
0
12,800
15,200
12,160
$15,200
12,160
27,360
(15,200)
640
$14,560
This assumes no warranty costs were paid in 20x9.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-40
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Assignment 16-19
Requirement 1
Year 1
Pretax accounting income ............... $58,000
Prepaid expense .............................. (30,000)
Taxable income (given) .................. 28,000
Tax rate ...........................................
36%
Income tax payable .........................$ 10,080
Year 2
$70,000
10,000
80,000
38%
$30,400
Year 3
$80,000
10,000
90,000
40%
$36,000
Year 4
$88,000
10,000
98,000
40%
$39,200
$30,400
$36,000
$39,200
(3,200)
$27,200
(3,600)
$32,400
(4,000)
$35,200
Requirement 2
Income tax payable .........................$ 10,080
Change in deferred income tax
See schedule, below .................. 10,800
$20,880
Tax Accounting
Basis
Basis
Year 1 – 36%
Prepaid expense
Year 2 – 38%
Prepaid expense
Year 3 – 40%
Prepaid expense
Year 4 – 40%
Prepaid expense
Temporary Deferred tax Opening Adjustment
Difference (Liab)/Asset Balance
$0
$30,000
($30,000)
($10,800)
0
20,000
( 20,000)
( 7,600)
( 10,800)
3,200
0
10,000
( 10,000)
( 4,000)
( 7,600)
3,600
0
0
( 4,000)
4,000
0
0
0
($10,800)
Requirement 3
Under the liability method, the effect of a change in tax rate on existing deferred income
tax balances is reflected in income when the tax rate changes. This can distort income tax
expense and earnings, but it does reflect the events of the year (change in rate) during the
year.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-41
Assignment 16-20
Requirement 1
Net income before tax
Permanent differences
Net income subject to tax
Temporary differences
Taxable income
tax rate
Current income tax
Temporary differences
tax rate
Adjustments for rate changes:
($1,000,000 + $88,000) × (40% – 36%)
($1,088,000 + $100,000) × (36% – 34%)
Deferred income tax
Income tax expense
20X7
$400,000
16,000
416,000
(88,000)
328,000
40%
$131,200
20X8
$440,000
20,000
460,000
(100,000)
360,000
36%
$129,600
20X9
$500,000
12,000
512,000
(104,000)
408,000
34%
$138,720
88,000
40%
35,200
100,000
36%
36,000
104,000
34%
35,360
(43,520)
35,200
$166,400
(7,520)
$122,080
(23,760)
11,600
$150,320
Requirement 2
If the reduced rates for 20X8 and 20X9 had been enacted in 20X7, the lower future rates
would be used to calculate the deferred income tax expense for 20X7. This would require
estimating the years in which the temporary differences will reverse. If no reversals are
expected, then the furthest known future tax rate (i.e., 20X9) would be used both for
reducing the beginning balance for 20X7 and for recording the increases in temporary
differences in each year. The rate reduction is recorded when it becomes enacted.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-42
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Assignment 16-21
Requirement 1
Income tax payable:
Accounting income
Permanent difference:
Golf club membership
Temporary difference:
Depreciation
CCA
Warranty expense
Warranty claims
Taxable income
Income tax payable (rate 38%; 40%)
Year 1
$2,500,000
Year 2
$ 2,750,000
30,000
0
240,000
(134,000)
514,000
(348,000)
$2,802,000
$1,064,760
240,000
(740,000)
574,000
(484,000)
$2,340,000
$936,000
Requirement 2
Year 1
Income tax payable (see Req.1) .... $1,064,760
Change in future tax:
Depreciation vs. CCA...............
(40,280)
Warranty ...................................
(63,080)
Income tax expense ....................... $961,400
(in 000’s)
Tax
Basis
Year 1 38%
Cap. assets
$1,786
Warranty
0
Year 2 40%
Cap. assets
1,046
Warranty
0
Year 2
$936,000
197,880
(39,320)
$1,094,560
Accounting Temporary Deferred tax Opening Adjustment
Basis
Difference (Liab)/Asset Balance
$1,680
(166)
$106
166
$40.28
63.08
1,440
(256)
(394)
256
(157.60)
102.40
Entries:
Year 1
Income tax expense. ...............................
Deferred income tax-warranty ...............
Deferred income tax-capital assets ........
Income tax payable .........................
0
0
40.28
63.08
$40.28
63.08
(197.88)
39.32
961,400
63,080
40,280
1,064,760
Year 2
Income tax expense ................................
Deferred income tax–warranty...............
Deferred income tax–capital assets
Income tax payable .........................
1,094,560
39,320
197,880
936,000
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-43
Assignment 16-22
Year 1
Accounting income
Political contribution
Accounting income subject to tax
Depreciation expense
CCA
Warranty expense
Warranty payments
Development costs incurred
Taxable income
Income tax payable rate 38%
(in 000’s)
Tax
Basis
Year 1 38%
Cap. assets
$3,420
Warranty
0
Dev. Costs
0
$2,200,000
20,000
$2,220,000
240,000
(180,000)
500,000
(380,000)
(200,000)
$2,200,000
$ 836,000
Accounting Temporary Deferred tax Opening Adjustment
Basis
Difference (Liab)/Asset Balance
$3,360
(120)
200
$60
120
(200)
$22.8
45.6
(76)
0
0
0
$22.8
45.6
(76)
Journal entry for Year 1:
Income tax expense
Deferred income tax – Capital assets
Deferred income tax – Warranty liability
Deferred income tax – Development costs
Income tax payable ($2,200,000 × 38%)
843,600
22,800
45,600
76,000
836,000
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-44
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Year 2
Accounting income
Golf club expense
Accounting income subject to tax
Depreciation expense
CCA
Warranty expense
Warranty payments
Development costs incurred
Amortization development costs
Taxable income
Income tax payable 40%
(in 000’s)
Tax
Basis
Year 2 40%
Cap. assets
$3,078
Warranty
0
Dev. Costs
0
$4,500,000
50,000
$4,550,000
240,000
(342,000)
600,000
(550,000)
(150,000)
58,000
$4,406,000
$1,762,400
Accounting Temporary Deferred tax Opening Adjustment
Basis
Difference (Liab)/Asset Balance
$3,120
(170)
292 (1)
($42)
170
(292)
($16.8)
68
(116.8)
22.8
45.6
(76)
($39.6)
22.4
(40.8)
(1) 200 – 58 +150
Journal entry for year 2:
Income tax expense
Deferred income tax – Warranty liability
Deferred income tax – Capital assets
Deferred income tax – Development costs
Income tax payable ($4,406,000 × 40%)
1,820,4000
22,400
39,600
40,800
1,762,400
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-45
Assignment 16-23 (WEB)
Net income before tax ..........................................
Timing differences:
Warranty: expense..........................................
tax deduction ................................
Franchise: accounting fee revenue .................
fees for tax purposes ....................
Taxable income ....................................................
Income tax payable (38%, 40%, 45%) .................
Income tax expense:
Income tax payable ........................................
Change in deferred income tax (see schedule)
Income tax expense ..............................................
Deferred income tax:
Tax
Basis
20x3 (38%)
Warranty
$0
Franchise
0
20x4 (40%)
Warranty
Franchise
0
0
20x5 (45%)
Warranty
Franchise
0
0
20x3
$75,000
20x4
$ 90,000
60,000
(15,000)
(90,000)
9,000
$39,000
$14,820
(20,000)
51,000
$121,000
$48,400
$14,820
13,680
$28,500
$48,400
(11,680)
$36,720
20x5
$80,000
(25,000)
30,000
$85,000
$38,250
$38,250
(2,000)
$36,250
Accounting Temporary Deferred tax Opening Adjustment
Basis
Difference (Liab)/Asset Balance
($45,000)
81,000
$45,000
(81,000)
$17,100
(30,780)
(25,000)
30,000
25,000
(30,000)
10,000
(12,000)
0
0
0
0
Entries:
20x3 Income tax expense .................................
Deferred income tax—warranty...............
Deferred income tax—franchise ..........
Income tax payable ..............................
0
0
$0
0
$17,100
(30,780)
(13,680)
17,100
(30,780)
(7,100)
18,780
11,680
10,000
(12,000)
(10,000)
12,000
2,000
28,500
17,100
30,780
14,820
20x4 Income tax expense .................................
Deferred income tax—franchise ..............
Deferred income tax—warranty ..........
Income tax payable ..............................
36,720
18,780
20x5 Income tax expense ..................................
Deferred income tax—franchise ..............
Deferred income tax—warranty..............
Income tax payable .............................
36,250
12,000
7,100
48,400
10,000
38,250
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-46
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Assignment 16-24
Requirement 1
Net income before tax .............................................................
Plus: permanent difference; political contribution .................
Accounting income subject to tax ...........................................
Temporary differences:
Depreciation expense ....................................................... $52,000
Capital cost allowance ..................................................... (15,600)
Warranty expense ............................................................
44,000
Warranty work completed ............................................... (30,000)
Development costs incurred ............................................ (200,000)
Revenue recognized ......................................................... (500,000)
Revenue collected ............................................................ 440,000
Taxable income from operations ............................................
Income tax payable ($85,400 × 30%) .....................................
(in 000’s)
Cap.
assets
Warranty
Dev costs
A/R
Tax
Basis
$764.4
0
0
0
Accounting
Basis
$728
(14)
200
60
Temporary
Difference
$36.4
14
(200)
(60)
Deferred
Tax Liability
$10.92
4.2
(60)
(18)
$290,000
5,000
$295,000
(209,600)
$ 85,400
$ 25,620
Opening
Balance
$0
Adjustment
0
0
0
4.2
(60)
(18)
$10.92
Journal entry:
Income tax expense
88,500
Deferred income tax asset – Warranty liability
4,200
Deferred income tax asset – Capital assets
10,920
Deferred income tax liability – Development costs
Deferred income tax liability – A/R
Income tax payable ($85,400 × 30%)
60,000
18,000
25,620
Requirement 2
Current income taxes
Deferred income taxes
Total income tax expense
25,620
62,880
$88,500
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-47
Requirement 3
Statement of Financial Position
Current assets:
Accounts receivable
$60,000
Long-term assets:
Development costs
Capital assets
200,000
728,000
Current liabilities:
Estimated warranty liability
Income tax payable
14,000
25,620
Long-term liabilities:
Deferred income tax liability
62,880
Assignment 16-25
Requirement 1
Taxable income/tax payable:
Accounting income ........................................................... $2,250,000
Non-deductible expenses golf club dues............................
32,000
Depreciation .......................................................................
200,000
CCA ...................................................................................
(300,000)
Collection ............................................................................
420,000
Taxable income .................................................................. $2,602,000
Tax payable @ 38% ........................................................... $ 988,760
DIT Table
(in 000’s)
AR
0
Capital assets
Warranty
(1)
(2)
Tax
Basis
3,300,000(2)
0
Accounting
NBV
130,000(1)
Temporary
Difference
Adj.
(49,400) (198,000)
148,600
4,600,000(3) (1,300,000) (494,000) (432,000)
(62,000)
(150,000)
(130,000)
DIT@.38
Opening
Balance
150,000
57,000
54,000
3,000
$550,000 – $420,000
$3,600,000 – 300,000
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-48
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
(3)
$4,800,000 – 200,000
Journal entry:
Income tax expense
Deferred income tax asset – Warranty liability
Deferred income tax liability – A/R
Deferred income tax liability – Capital assets
Income tax payable
899,160
3,000
148,600
62,000
988,760
Requirement 2
Deferred income tax asset – warranty
Deferred income tax liability
Estimated warranty liability
Net book value of capital assets
Accounts receivable
Undepreciated capital cost
$ 57,000
543,400
150,000
4,600,000
130,000
3,300,000
Assignment 16-26
Requirement 1
Calculation of taxable income/tax payable
Accounting income ………………….
Dividend revenue…………………….
Political contributions …………….…
Depreciation………………………….
CCA………………………………….
Warranty expense……………………
Warranty claims paid………………...
LT Receivable……………………….
Taxable income………………………
Tax payable@40%...............................
20X9
$280,000
(32,000)
40,000
126,000
(100,000)
92,000
(92,000)
80,000
$394,000
157,600
DIT Table (in thousands)
Tax
basis
Capital Assets
Warranty
LT Receivable
860
0
0
Accounting Temporary
NBV
difference
1,464
(98)
160
(604)
98
(160)
Deferred
income
tax
@40%
(241.6)
39.2
(64)
Opening
balance
(239.4) (1)
37.24 (2)
(91.2) (3)
Adj.
(2.2)
1.96
27.2
(1) $1,590 – $960 = $630 × 38% = $239.4
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-49
(2) $98 × 38% = $37.24
(3) $240 × 38% = $91.2
Journal Entry:
Tax expense ................................................................................
Deferred income tax – warranty...................................................
Deferred income tax – LT receivable ..........................................
Deferred income tax – capital assets ...............................
Tax payable ......................................................................
130,640
1,960
27,200
2,200
157,600
Income tax expense is $130,640
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-50
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Assignment 16-27
20x1
Net income before tax .......................................... $100,000
Permanent differences:
Dividend income ............................................
(2,000)
Accounting income subject to tax .......................
98,000
Temporary differences
Warranty expense ...........................................
3,000
Warranty costs................................................
(1,000)
Depreciation ................................................
10,000
CCA ............................................................... (25,000)
Pension expense .............................................
5,000
Pension funding .............................................
(7,000)
Total temporary differences ..................... (15,000)
Taxable income .................................................... $ 83,000
Tax rate ................................................................
40%
Income tax payable .............................................. $ 33,200
Income tax expense:
Income tax payable .............................................. $ 33,200
Change in deferred income tax (see schedule) ....
6,000
Income tax expense .............................................. $ 39,200
20x2
$100,000
20x3
$100,000
(2,000)
98,000
(3,000)
97,000
3,000
(4,000)
10,000
(15,000)
7,000
(8,000)
(7,000)
$ 91,000
44%
$ 40,040
3,000
(3,000)
12,000
(7,000)
10,000
(9,000)
6,000
$103,000
48%
$ 49,440
$ 40,040
3,680
$ 43,720
$ 49,440
(2,000)
$ 47,440
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-51
Tax
Basis
Accounting
Basis
Temp.
Difference
Deferred
Income Tax
Opening
Balance
Adjustment
20x1 – 40%
Warranty
Capital Assets
Pension
$0
95,000
0
($2,000)
110,000
2,000
$2,000
(15,000)
(2,000)
$800
(6,000)
(800)
20x2 – 44%
Warranty
Capital Assets
Pension
$0
80,000
0
($1,000)
100,000
3,000
$1,000
(20,000)
(3,000)
$440
(8,800)
(1,320)
$800
(6,000)
(800)
($360)
(2,800)
(520)
(3,680)
20x3 – 48%
Warranty
Capital Assets
Pension
$0
73,000
0
($1,000)
88,000
2,000
$1,000
(15,000)
(2,000)
$480
(7,200)
(960)
$440
(8,800)
(1,320)
$40
1,600
360
2,000
Entries
20x1
Income tax expense................................................................
Deferred income tax – warranty ............................................
Deferred income tax – capital assets .................................
Deferred income tax – pension ........................................
Income tax payable ...........................................................
20x2
Income tax expense................................................................
Deferred income tax – warranty........................................
Deferred income tax – capital assets .................................
Deferred income tax – pension ........................................
Income tax payable ...........................................................
20x3
Income tax expense................................................................
Deferred income tax – capital assets .....................................
Deferred income tax – pension .............................................
Deferred income tax – warranty ............................................
Income tax payable ...........................................................
$0
0
0
$800
(6,000)
(800)
(6,000)
39,200
800
6,000
800
33,200
43,720
360
2,800
520
40,040
47,440
1,600
360
40
49,440
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-52
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Assignment 16-28
Requirement 1
20x4
Depreciation
$40,000/10 = $4,000 ............................................
$4,000 + $53,000 ($689,000/13)..........................
$4,000 + $53,000 + $37,500 ($450,000/12) ........
ITC Amortization:
20x4 ($5,600/10) = $560 .....................................
20x5 $560 + ($96,460/13) $7,420 .......................
20x6 $560 + $7,420 + ($63,000/12) $5,250 ........
................................................
(1) 4,000 x 14% = 560
20x5
20x6
$4,000 (1)
$57,000
94,500
(560)
(7,980)
$3,440
$49,020
(13,230)
$81,270
Requirement 2
20x4
Income before tax ................................................ $165,000
Plus: non-deductible advertising .........................
20,000
Temporary differences
Depreciation (Part 1) ......................................
3,440
CCA (given) ................................................ (12,000)
Taxable income ................................................ 176,440
Income tax payable (25%) ...................................
44,110
Less: ITC
20x4: $40,000 × 14% .....................................
(5,600)
20x5: $689,000 × 14% ...................................
20x6: $450,000 × 14% ...................................
Net income tax payable ........................................ $ 38,510
20x5
$456,000
20,000
20x6
$468,000
20,000
49,020
(135,000)
390,020
97,505
81,270
(216,000)
353,270
88,318
(96,460)
$ 1,045
(63,000)
$25,318
20x4
20x5
20x6
$44,110
$97,505
Requirement 3
Income tax expense
Income tax payable ........................................
Increase in deferred income tax:
($12,000 – $3,440) × 25% .............................
($135,000 – $49,020) × 25% .........................
($216,000 – $81,270) × 25% .........................
$ 88,318
2,140
21,495
$ 46,250
$119,000
33,683
$122,001
$ 38,510
$ 1,045
$25,318
Requirement 4
Income tax expense (tax payable) (Req. 2) ....
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-53
Requirement 5
The cost reduction approach is preferable because it better matches the tax benefit with its
root cause. It shows the net cost of assets to the owners and eliminates the potential to
materially manipulate earnings.
Requirement 6
Capital Assets:
Capital assets ..................................................
Less: Accumulated depreciation..................
Deferred investment tax credit (1) .....
$40,000
(4,000)
(5,040)
$30,960
(1) $5,600 – $560
May also be shown as a deferred credit on the statement of financial position.
Assignment 16-29
Year 1
Accounting income
Political contribution
Accounting income subject to tax
Depreciation expense
CCA
Warranty expense
Warranty payments
Development costs incurred
Taxable income
Income tax payable rate 38%
$2,200,000
20,000
$2,220,000
240,000
(180,000)
500,000
(380,000)
(200,000)
$2,200,000
$ 836,000
Journal entry for Year 1:
Income tax expense
Income tax payable ($2,200,000 × 38%)
836,000
836,000
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-54
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
Year 2
Accounting income
Golf club expense
Accounting income subject to tax
Depreciation expense
CCA
Warranty expense
Warranty payments
Development costs incurred
Amortization development costs
Taxable income
Income tax payable 40%
$4,500,000
50,000
$4,550,000
240,000
(342,000)
600,000
(550,000)
(150,000)
58,000
$4,406,000
$1,762,400
Journal entry for year 2:
Income tax expense
Income tax payable ($4,406,000 × 40%)
1,762,400
1,762,400
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition
16-55
Assignment 16-30
Requirement 1
Net income before tax .............................................................
Plus: permanent difference; political contribution .................
Accounting income subject to tax ...........................................
Temporary differences:
Depreciation expense ....................................................... $52,000
Capital cost allowance ..................................................... (15,600)
Warranty expense ............................................................
44,000
Warranty work completed ............................................... (30,000)
Development costs incurred ............................................ (200,000)
Revenue recognized ......................................................... (500,000)
Revenue collected ............................................................ 440,000
Taxable income from operations ............................................
Income tax payable ($85,400 × 30%) .....................................
$290,000
5,000
$295,000
(209,600)
$ 85,400
$ 25,620
Journal entry:
Income tax expense
Income tax payable ($85,400 × 30%)
25,620
25,620
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.
16-56
Solutions Manual to accompany Intermediate Accounting Volume 2, 6th edition