Chapter 7 (Unit 6) Accounting for Income Taxes

Question 1

Assume Skywalker, Inc. has $160 of operating revenues and $40 of operating expenses.

Included in GAAP revenue is $20 worth of service with payment expected next year. This revenue is not taxed until received in cash.

In addition to the operating results, there is $10 of tax-exempt interest on bonds issued by the State of Texas. There is no federal income tax levied on such interest.

What is the journal entry for Income taxes?

Answer 1

D: Income Tax Expense 36
C: Deferred Tax Liability 6
C: Income Tax Payable 30

Question 2

DTA or DTL:

GAAP assets > tax value

Answer 2

DTL

Question 3

DTA or DTL:

GAAP liabilities > tax value

Answer 3

DTA

Question 4

DTA or DTL:
GAAP assets < tax value

Answer 4

DTA

Question 5

DTA or DTL:
GAAP liabilities < tax value

Answer 5

DTL

Question 6

CPA-3PO has three financial statement elements for which the December 31 book value is different than the December 31 tax basis:

Equipment = BV 200,000, TB 120,000
Prepaid Officer’s Insurance Policy = BV 75,000, TB 0
Warranty Liability = BV 50,000, TB 0

As a result of these differences, what are the future gross taxable amounts, ignoring deductible amounts?

Answer 6

Equipment = DTL of 80,000

Prepaid Officers = Permanent Difference (N/A)

Warranty Liability = DTA of 50,000

Future gross taxable amount = 80,000

Question 7

What are 4 common temporary differences?

Answer 7

1. Depreciation
2. Revenue Recognition
3. Warranty Expense and Bad Debt Expense
4. Income from Investments (Only dividends are taxable, not share of NI)

Question 8

Carnes completes services in year 1 and charges $10,000 for the work; receives $1,000 cash this year. The customer is expected to remit the remaining $9,000 payment next year. There are no expenses. Tax rate is 30%

a) What is the originating difference?
b) What is the amount of the DTL?
c) What is the income tax payable in year 1?
d) What is the journal entry in year 2 when the deferred tax is owed?

Answer 8

a) 9,000
b) 9,000 x 0.30 = 2,700
c) 1,000 x 0.30 = 300
d)
D: Deferred Tax Liability 2,700
C: Income Tax Payable 2,700

Question 9

Assume Carnes has a warranty expense of 6,000 in year 1 on year 1 sales (1-year warranty). No warranty claims in year 1. Warranty expense is recognized for books.

Also assume $10,000 of revenues and the warranty is the only expense. The tax rate is 30%.

a) What is the originating difference?
b) What is the amount of the DTA?

Answer 9

a) $6,000
b) 6,000 x 0.30 = 1,800

Question 10

What are 5 common permanent differences?

Answer 10

1. Tax-exempt interest
2. Fines and penalties
3. Life insurance premiums on key employees (when firm is beneficiary)
   Proceeds from such a policy are not taxable but are a gain for the books
4. 50% of meals
5. Dividends received deduction (DRD)

Question 11

Define Dividends Received Deduction

Answer 11

When one corporation receives dividends from another corporation, a portion of that dividend is tax free.

If 80% is excluded, then only 20% of the dividends received are included in taxable income.

Question 12

Assume an R2-FAR2 has $2,000 of revenues less expenses for books and tax for the year. The entity also received $400 of dividends that qualify for the 80% DRD. The tax rate is 30%.

a) What is the DRD?

b) What is the taxable income?

c) What is the income taxes payable?

Answer 12

a) 400 x 0.80 = 320

b) 2,400 - 320 = 2,080

c) 2,080 x 0.30 = 624

Question 13

BB-Great has $800 of GAAP pre-tax income that includes a $200 fine for a securities law violation. Fines or penalties are generally not tax deductible. Taxable income would be $1,000. The tax rate is 30%.

a) What is the tax accrual entry?

b) What is the effective tax rate?

Answer 13

a)
D: Income tax expense 300
C: Income tax payable 300

b)
300 / 800 = 37.5%
7.5% increase in the rate is due to the non-deductibility of the fine

Question 14

How is the effective tax rate calculated?

Answer 14

Income tax expense /Pre Tax Income

Question 15

How is Total Tax Expense calculated?

Answer 15

Taxes Currently Payable + Increase in DTL - Increase in DTA

Question 16

How are deferred taxes shown on the financial statements?

Answer 16

On the balance sheet, deferred taxes are shown as one net noncurrent asset or liability.

Ex. a 46,000 deferred tax liability and a 19,000 tax asset would appear on the balance sheet as a 27,000 noncurrent liability

Question 17

What is a Valuation Allowance for a deferred tax asset?

Answer 17

A valuation allowance account recognizes the reduction in the carrying amount of deferred tax asset.

Based on available evidence, a company should reduce a deferred tax asset by a valuation allowance if it is more likely than not that it will not realize some portion or all of the deferred tax asset.

More likely than not means a level of likelihood of at least slightly more than 50%.

Question 18

Honey Hops Corporation has a deferred tax asset account with a balance of $120,000 at the end of 2013 due to a single cumulative temporary difference of $250,000. At the end of 2014, this same temporary difference has increased to a cumulative amount of $350,000. Taxable income for 2013 is $800,000. The tax rate is 40% for all years. At the end of 2013, honey Hops Corporation had a valuation account related to its deferred tax asset of $60,000.

a) Record income tax expense, deferred income taxes, and income taxes payable for 2014, assuming that it is more likely than not that the deferred tax asset will be realized in full.

b) Record income tax expense, deferred income taxes, and income taxes payable for 204, assuming that it is more likely than not that none of the deferred tax asset with be realized.

Answer 18

a)
D: Income Tax Expense 300,000
C: Deferred Tax Asset 20,000 (350,000 x 0.40 = 140,000; 140,000-120,000)
C: Income Taxes Payable 320,000 (800,000 x 0.40)

D: Allowance to Reduce DTA to Expected Realizable Value 60,000 (remove balance)
C: Income Tax Expense 60,000

b)
D: Income Tax Expense 300,000
C: Deferred Tax Asset 20,000 (350,000 x 0.40 = 140,000; 140,000-120,000)
C: Income Taxes Payable 320,000 (800,000 x 0.40)

D: Income Tax Expense 80,000 (140,000 DTA - 60,000 valuation beg bal.)
C: Allowance to Reduce DTA to Expected Realizable Value 80,000

Question 19

The following incormation is available for Monty Corporation for 2016 (its first year of operations).

1. Excess of tax depreciation over book depreciation, $40,000. This $40,000 difference will reverse equally over the years 2017-2020.
2. Deferral, for book purposes of $21,500 of rent received in advance. The rent will be recognized in 2017.
3. Pretax financial income, $315,900.
4. Tax rate for all years, 40%

a) Compute taxable income for 2016.

b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2016.

c) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2017, assuming taxable income of $303,600

Answer 19

a) 297,400

b)
D: Income Tax Expense 126,360
D: Deferred Tax Asset 8,600
C: Deferred Tax Liability 16,000
C: Income Taxes Payable 118,960

c)
D: Income Tax Expense 126,040
D: Deferred Tax Liability 4,000
C: Deferred Tax Asset 8,600
C: Income Tax Payable 121,440