18 Example B

Question 1

Harper Company began operations at the beginning of 2021. The following information pertains to this company.

1. Pretax financial income:
   2021: $850,000
   2022: $1,250,000
   2023: $2,875,000
2. The tax rate enacted for 2021 is 20%.
3. Differences between the 2021 income statement and tax return are listed below:

a) Interest revenue earned on an investment in tax-exempt municipal bonds amounts to $3,000 in 2021, $1,500 in 2022, and $2,000 in 2023.

b) Revenue in 2023 on a construction contract is $800,000 for tax purposes. For financial statement purposes, revenue will amount to $100,000 in 2021, $300,000 in 2022, and the remainder in 2023. This is Harper’s only construction contract during 2021-2023.

c) Depreciation of equipment for financial reporting purposes is calculated using the straight-line method. Harper purchased equipment on January 1, 2022 at a cost of $50,000. The equipment has a life of 5 years and a $5,000 salvage value. Depreciation of the equipment for the tax return will be based on double-declining balance with a life of 4-years.

d) A $12,500 fine paid for violation of EPA laws was deducted in computing pretax financial income in 2022.

e) Rent collected in advance on January 1, 2021, totaled $15,000 for a 3-year period.

4. Taxable income is expected for the next few years.

REQUIRED:

a) Below and on the following page, compute taxable income for 2021, 2022, and 2023.

b) Prepare the journal entries on December 31, 2021, 2022, and 2023 related to taxes.

Answer 1

Construction Contract:
2021: (Fin) 100,000 – (Tax) 800,000 = (700,000)
2022: (Fin) 300,000 – (Tax) 0 = 300,000
2023: (Fin) 2,475,000 – (Tax) 0 = 2,475,000

Rent:
2021: (Fin) 5,000 – (Tax) 15,000 = (10,000)
2022: (Fin) 5,000 – (Tax) 0 = 5,000
2023: N/A

Depreciation:
2 / 4 (double-declining balance) = 50%

Fin: (50,000 – 5,000) / 5 = 9,000 per year
Tax (2022): 50% × 50,000 = 25,000
Tax (2023): 50% × (50,000 – 25,000) = 12,500

2021: N/A
2022: (Fin) 9,000 – (Tax) 25,000 = (16,000)
2023: (Fin) 9,000 – (Tax) 12,500 = (3,500)

2021:
D - Income Tax Expense (847,000 x 20%): 169,400
D - Deferred Tax Asset: 2,000
C - Deferred Tax Liability: 20,000
C - Income Tax Payable (757,000 x 20%): 151,400

2022:
D - Income Tax Expense (1,261,000 x 20%): 252,200
C - Deferred Tax Asset: 1,000
C - Deferred Tax Liability: 60,000
C - Deferred Tax Liability: 3,200
C - Income Tax Payable (940,000 x 20%): 188,000

2023:
D - Income Tax Expense (2,873,000 x 20%): 574,600
D - Deferred Tax Liability: 80,000
C - Deferred Tax Asset: 1,000
C - Deferred Tax Liability: 700
C - Income Tax Payable (3,264,500 x 20%): 652,900