Deferred Taxes

IA/PE

Deferred Taxes

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TEMPORARY DIFFERENCES

Caused by: Two Types: 1.

2.

Example Books Now Tax Later Label

Example Books Later Tax Now Label

Deferred Taxes

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PERMANENT DIFFERENCES

Caused by: Common Permanent Differences: 1.

2.

3.

4.

Other Notes:

Deferred Taxes

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Example:

BOOKS TAX

Income Before Permanent Difference $ $

Life Insurance Premium

Interest on Municipal Bonds

Dividends

Income $ $

Journal Entry to record taxes:

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Ways Asked On the CPA Exam: 1.

2.

3. Other Notes:

Deferred Taxes

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MULTIPLE CHOICE QUESTIONS 1 - 4

1. For the year ended December 31. 2001, Mont Co.’s books showed income of $600,000 before provision for income tax expense. To compute taxable income for federal income tax purposes, the following items should be noted: Income from exempt municipal

bonds $60,000 Depreciation deducted for tax

purposes in excess of depreciation recorded on the books 120,000

Proceeds received from life insurance on death of officer 100,000

Estimated tax payments 0 Enacted corporate rate 30% Ignoring the alternative minimum tax provisions, what amount should Mont report at December 31, 2001, as its current federal income tax liability? a. $96,000 b. $114,000 c. $150,000 d. $162,000

2. Kemp Corporation’s income statement for the year ended December 31, 2007, shows pretax income of $500,000. The following items are treated differently on the tax return and on the accounting records: Tax

Return

Accounting Records

Rent income $35,000 $60,000 Depreciation Expense 140,000 110,000

Premium on Officer’s life insurance none 45,000

Assume that Kemp’s tax rate for 2007 is 40%. What is the current portion of Kemp’s total income tax expense for 2007? a. $218,000 b. $200,000 c. $196,000 d. $178,000

Deferred Taxes

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3. Dunn Co.’s 2007 income statement reported $90,000 income before provisions for income taxes. To compute the provision for federal income taxes, the following 2007 data are provided: Rent received in advance $16,000

Income from exempt municipal bonds 20,000

Depreciation deducted for income tax purposes in excess of depreciation reported of financial statement purposes 10,000

Estimated tax payments 0

Enacted corporate income tax rate 30% If the alternative minimum tax provisions are ignored, what amount of current federal income tax liability should be reported in Dunn’s December 31, 2007 balance sheet? a. $18,000 b. $22,800 c. $25,000 d. $28,800

4. Pine Corp.’s books showed pretax income of $800,000 for the year ended December 31, 2007. In the computation of federal income taxes, the following data were considered: Gain on an involuntary conversion

(Pine has elected to replace the property within the statutory period using total proceeds.) $350,000

Depreciation deducted for tax purposes in excess of depreciation deducted for book purposes 50,000

Federal estimated tax payments, 2007 70,000

Enacted federal tax rates, 2007 30% What amount should Pine report as its current federal income tax liability on its December 31, 2007 balance sheet? a. $50,000 b. $65,000 c. $120,000 d. $135,000

(3311)

Deferred Taxes

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ILLUSTRATIVE PROBLEM

For the year ended December 31, 2001, Bay company’s books showed income of $800,000. To compute taxable income, the following reconciling items should be noted:

$260,000 Life Insurance Premiums (with corporation as the beneficiary)

$100,000 Interest from Municipal Bonds

$600,000 greater Depreciation on tax return

$50,000 Accrued Warranty Expense on books that will be deducted on tax return in the year 2004

Enacted tax rates are as follows:

2001 – 35% 2002 – 30% 2003 – 25% 2004 – 20%

Required: a. Reconcile book and taxable income Required: b. Prepare the journal entry for the current portion of income tax expense

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Deferred Taxes

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FUTURE TAXABLE AMOUNT

Definition: Deferred Income Tax Liability =

×

Continuing with Illustrative Problem: Required: c. Determine the Deferred Tax Liability

Deferred Taxes

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FUTURE DEDUCTIBLE AMOUNTS

Definition: Definition: Deferred Income Tax Asset =

×

Deferred Income Tax Asset =

×

Continuing with Illustrative Problem: Required: d. Determine the Deferred Tax Asset

Deferred Taxes

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Continuing with Illustrative Problem: Required: e. Prepare the journal entry to recognize the deferred tax liability and deferred tax

asset.

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Deferred Tax Expense: Deferred Tax Benefit: Other Notes:

Deferred Taxes

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FINANCIAL STATEMENT PRESENTATION

Income Statement Presentation: Continuing with Illustrative Problem: Required: f. Show how Income Tax Expense is treated in the Income Statement. Balance Sheet Presentation: Rule: Continuing with Illustrative Problem: Required: g. Show how the Deferred Tax Liability and Deferred Tax Asset are included in the Balance Sheet.

Deferred Taxes

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VALUATION ALLOWANCE ACCOUNT

Continuing with Illustrative Problem: Required: h. If it is more likely than not that $3,000 of the deferred tax asset will never be realized,

prepare the journal entry required to reflect this situation.

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Deferred Taxes

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MULTIPLE CHOICE QUESTIONS 5 - 17

5. Frey Corp., a construction company, appropriately uses the completed contract method of accounting for income tax purposes. However, Frey uses the percentage of completion accounting method for financial statement purposes. Pertinent data at December 31, 2002, the close of Frey’s first year of operations, are:

Date contract began

Estimated completion

date

Income recognized in 2002 on each

contract

3/1/02 9/1/03 $600,000 6/1/02 12/1/03 300,000 9/1/02 3/1/04 200,000

12/1/02 6/1/04 100,000 Frey’s enacted income tax rates are 30% for 2002, 25% for 2003 and 20% for 2004. Frey elected early application of FASB Statement No. 109, Accounting for Income Taxes, in its financial statements for the year ended December 31, 2002. Assuming Frey expects taxable income in all future periods, what amount should be included in the deferred income tax liability at December 31, 2002, for these transactions? a. $360,000 b. $330,000 c. $285,000 d. $240,000

6. Black Co., organized on January 2, 2007, had pretax accounting income of $500,000 and taxable income of $800,000 for the year ended December 31, 2007. The only temporary difference is accrued product warranty costs which are expected to be paid as follows:

2008 $100,000

2009 50,000

2010 50,000

2011 100,000

The enacted income tax rates are 35% for 2008, 30% for 2009 through 2010, and 25% for 2011. Taxable income is expected in all future years. In Blacks December 31, 2007 balance sheet, the deferred income tax asset should be a. $75,000. b. $85,000. c. $90,000. d. $105,000.

(3306)

Deferred Taxes

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7. Cory Inc. uses the accrual method of accounting for financial reporting purposes and appropriately uses the installment method of accounting for income tax purposes. Installment income of $250,000 will be collected in the following years when the enacted tax rates are: Collection of income Enacted tax rates

2007 $25,000 35% 2008 50,000 30% 2009 75,000 30% 2010 100,000 25%

The installment income is Cory’s only temporary difference. Taxable income is expected in all future years. What amount should be included in the deferred income tax liability in Cory’s December 31, 2007 balance sheet? a. $62,500 b. $71,250 c. $78,750 d. $87,500

(3301) 8. Shear, Inc., began operations in 2007. Included in Shear’s 2007 financial statements were bad debt expenses of $1,400 and profit from an installment sale of $2,600. For tax purposes, the bad debts will be deducted and the profit from the installment sale will be recognized in 2009. The enacted tax rates are 30% in 2007 and 25% in 2009. Shear expects to operate profitably in all future years. In its 2007 income statement, what amount should Shear report as deferred income tax expense? a. $300 b. $360 c. $650 d. $780

(3313)

9. For calendar year 2007, Clark Corp. reported depreciation of $300,000 in its income statement. On its 2007 income tax return, Clark reported depreciation of $500,000. Clark’s income statement also included $50,000 accrued warranty expense that will be deducted for tax purposes when paid. Clark’s enacted tax rates are 30% for 2007 and 2008, and 25% for 2009 and 2010. The depreciation difference and warranty expense will reverse over the next three years as follows:

Depreciation Difference

Warranty Expense

2008 $80,000 $10,000 2009 70,000 15,000 2010 50,000 25,000

$200,000 $50,000

These were Clark’s only temporary differences. In Clark’s 2007 income statement, the deferred portion of its provision for income taxes should be a. $67,000. b. $46,000. c. $41,000. d. $37,500.

(3314)

Deferred Taxes

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In addition to answering 10 and 11, prepare the journal entries for the current portion of income tax expense and for the deferred portion of income tax expense for Kent, Inc., and calculate total income tax expense. Items 10 and 11 are based on the following: Kent, Inc.’s reconciliation between financial statement and taxable income for 2007 follows: Pretax financial income $150,000 Permanent difference (12.000)

138,000

Temporary difference — Depreciation (9,000)

Taxable income $129,000

Additional information: At

12/31/06 At

12/31/07

Cumulative temporary differences (future taxable amounts) $11,000 $20,000

The enacted tax rate was 34% for 2006, and 40% for 2007 and years thereafter. Journal entry for current portion of income tax expense: 10. In its 2007 income statement, what amount should Kent report as current portion of income tax expense? a. $51,600 b. $55,200 c. $55,860 d. $60,000

(5311)

Journal entry for deferred portion of income tax expense: 11. In its December 31, 2007 balance sheet, what amount should Kent report as deferred income tax liability? a. $3,600 b. $6,800 c. $7,340 d. $8,000

(5310) 12. Because Jab Co. uses different methods to depreciate equipment for financial statement and income tax purposes, Jab has temporary differences that will reverse during the next year and add to taxable income. Deferred income taxes that are based on these temporary differences should be classified in Jab’s balance sheet as a a. Contra account to current assets. b. Contra account to noncurrent assets. c. Current liability. d. Noncurrent liability.

(4839) 13. On its December 31, 2007, balance sheet, Shin Co. had income taxes payable of $13,000 and a current deferred tax asset of $20,000 before determining the need for a valuation account. Shin had reported a current deferred tax asset of $15,000 at December 31, 2006. No estimated tax payments were made during 2007. At December 31, 2007, Shin determined that it was more likely than not that 10% of the deferred tax asset would not be realized. In its 2007 income statement, what amount should Shin report as total income tax expense? a. $8,000 b. $8,500 c. $10,000 d. $13,000

(6118)

Deferred Taxes

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14. Panda Corp.’s income statement for the year ended December 31, shows pretax income of $300,000. The following items are treated differently on the tax return and on the accounting records: Tax

Return

Accounting records

Depreciation $95,000 $70,000 Royalty income 80,000 50,000 Premiums on life insurance None 5,000 Bad debt expense 7,000 12,000 Life insurance proceeds None 20,000

Assume that Panda’s tax rate is 30% and Panda made estimated tax payments of $15,000. What is the current portion of Panda’s income tax expense? a. $ 88,500 b. $103,500 c. $ 73,500 d. $ 85,500

Items 15 through 17 are based on the following: Paxton Inc.’s reconciliation between financial statement and taxable income for 2006 follows: Pretax financial income $750,000 Permanent diff) (25,000)

725,000 Term diff-depreciation (60,000) Term diff-disallowed warranty exp 50,000

Taxable income $715,000

The enacted tax rate was 30% for 2006 and 35% for years thereafter. Paxton estimates that 10% of any deferred tax asset will never be realized. 15. In its December 31, 2006 balance sheet, what amount would Paxton report as deferred income tax asset? a. $17,500 b. $21,000 c. $15,750 d. $18,900 16. In its December 31, 2006 balance sheet, what amount would Paxton report as deferred income tax liability? a. $18,000 b. $21,000 c. $18,900 d. $17,500 17. In its 2006 income statement, what would Paxton report as total income tax expense? a. $214,500 b. $250,250 c. $219,750 d. $218,000

Deferred Taxes

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EXAMPLE

Parent company owns 30% of a Subsidiary’s stock and uses the equity method to account for this investment. The subsidiary’s earned $100,000 in income and paid $20,000 in dividends during the first year of the investment. The journal entry to recognize Sub’s income on Parent’s books:

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The journal entry to record Sub’s dividends on Parent’s books:

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The current tax rate is 40% and the future tax rate is 30%. The dividends are eligible for the 80% dividends received deduction. Calculate the amount of income taxes payable by Parent on the dividends received from Subsidiary and prepare the journal entry.

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Calculate Parent’s deferred tax liability on the future dividends and prepare the journal entry.

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Deferred Taxes

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MULTIPLE CHOICE QUESTION 18 - 20

18. Bart Inc., a newly organized corporation, uses the equity method of accounting for its 30% investment in Rex Co.’s common stock. During 2007, Rex paid dividends of $300,000 and reported earnings of $900,000. In addition: The dividends received from Rex are

eligible for the 80% dividends received deduction.

All the undistributed earnings of Rex will be distributed in future years.

There are no other temporary differences.

Bart’s 2007 income tax rate is 30%. The enacted income tax rate after 2007 is

25%. Bart expects taxable income in all future

years. In Bart’s December 31, 2007 balance sheet, the deferred income tax liability should be a. $10,800. b. $ 9,000. c. $ 5,400. d. $ 4,500

(3322) 19. On January 1, 2006, Pesto Co. purchased 35% of the voting common stock of Surry Co, and appropriately accounts for the investment by the equity method. During 2006, Surry reported earnings of $200,000 and paid dividends of $40,000. Pesto’s current enacted income tax rate is 28%. In addition:

The dividends received from Surry are eligible for the 80% dividends received deduction.

The income tax rate enacted for future periods is 30%.

In Pesto’s December 31, 2006 balance sheet the deferred income tax liability should be a. $16,800 b. $15,680 c. $ 3,136 d. $ 3,360 20. Leer Corp.’s pretax income in 2010 was $100,000. The temporary differences between amounts reported in the financial statements and the tax return are as follows: Depreciation in the financial statements

was $8,000 more than tax depreciation.

The equity method of accounting resulted in financial statement income of $35,000. A $25,000 dividend was received during the year, which is eligible for the 80% dividends received deduction.

Leer’s effective income tax rate was 30% in 2010. In its 2010 income statement, Leer should report a current provision for income taxes of a. $26,400 b. $23,400 c. $21,900 d. $17,400

Deferred Taxes

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LOSS CARRYBACK & CARRYFORWARD

NOL: Example:

2009 NOL $

Income 2007, 2008

Loss Carryback:

Loss Carryback

Tax Rate %

Tax Benefit From Carryback $

Journal entry to record tax benefit from carryback:

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Loss Carryback: Loss Carryback $

Tax Rate %

Tax Benefit From Carryback $

Tax benefit from loss carryforward is reported as Journal entry to record tax benefit from carryforward:

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Deferred Taxes

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If it is more likely than not that $4,000 of the deferred tax asset will never be realized, journal entry is:

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INCOME STATEMENT PRESENTATION

2009 Loss Before Tax $

Loss:

Loss Benefit From Carryback

Loss Benefit From Carryforward

Net Loss $

Deferred Taxes

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SIMULATION

Items 1 through 4 describe circumstances resulting in differences between financial statement income and taxable income. Select the best answer for each item. For each numbered item, determine whether the difference is:

List

A. A temporary difference resulting in a deferred tax asset

B. A temporary difference resulting in a deferred tax liability

C. A permanent difference

An answer may be selected once, more than once, or not at all. 1. For plant assets, the depreciation expense deducted for tax purposes is in excess of

the depreciation expense used for financial reporting purposes.

2. A landlord collects some rents in advance. Rents received are taxable in the period in which they are received.

3. Interest is received on an investment in tax-exempt municipal obligations.

4. Costs of guarantees and warranties are estimated.

Deferred Taxes

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Items 5 through 8 represent amounts omitted from the following worksheet. For each item, determine the amount omitted from the worksheet. Select the amount from the following list. An answer may be used once, more than once, or not at all. The partially completed worksheet contains Lane Co.’s reconciliation between financial statement income and taxable income for the three years ended April 30, 2007, and additional information. The tax rate changes were enacted at the beginning of each tax year and were not known to Lane at the end of the prior year.

5. Current tax expense for the year ended April 30, 2005

Amount

6. Cumulative temporary differences at April 30, 2006

A. $25,000 B. $35,000 C. $45,000 D. $75,000 E. $100,000 F. $120,000 G. $112,500

H. $135,000 I. $140,000 J. $160,000 K. $180,000 L. $200,000 M. $300,000 N. $400,000

7. Deferred tax expense for the year ended April 30, 2006.

8. Deferred tax liability at April 30, 2007

Lane Co. INCOME TAX WORKSHEET

For the Three Years Ended April 30, 2007

April 30, 2005 April 30, 2006 April 30, 2007

Pretax financial income $900,000 $1,200,000 $1,000,000

Permanent differences 100,000 100,000 100,000

Temporary differences 200,000 100,000 150,000

Taxable income $600,000 $ 800,000 $ 950,000

Cumulative temporary differences (future taxable amounts) $200,000 $ (6) $ 450,000

Tax rate 20% 25% 30%

Deferred tax liability $ 40,000 $ 75,000 $ (8)

Deferred tax expense $ - $ (7) $ -

Current tax expense $ (5) $ - $ -