Deferred Tax Paper 4

(c) Income tax expense must be reported in two components: the amount currently payable (current portion) and the tax effects of temporary differences (deferred portion). The current portion is computed by multiplying taxable income by the current enacted tax rate ($200,000 × 30% = $60,000). The deferred portion is $30,000 ($100,000 temporary difference × 30%). An alternative computation for the deferred portion is shown below.
DT asset at 12/31/Y2 $ 0
DT asset at 12/31/Y1 9,000
Decrease in DT asset $ 9,000
DT liability at 12/31/Y2 ($70,000 × 30%) $21,000
DT liability at 12/31/Y1 0
Increase in DT liability 21,000
Deferred portion of tax expense $30,000

(d) The deferred income tax expense or benefit is the net change during the year in an enterprise’s deferred tax liabilities or assets. The deferred income tax expense or benefit must consider the net effect of changes (both increases and decreases) in both deferred tax assets and deferred tax liabilities. The decrease in deferred tax assets alone or the increase in deferred tax liabilities alone will not be equal to the deferred income tax expense. The amount of income tax liability (current portion which comes off the tax return) plus the sum of the net changes in deferred tax assets and deferred tax liabilities is the total amount of income tax expense or benefit for the year. The question asks only for the deferred portion.

(c) From 12/31/Y1 to 12/31/Y2, the deferred tax asset increased by $5,000 (from $15,000 to $20,000). Income taxes payable at 12/31/Y2 are $13,000. Based on this information, the following journal entries can be recreated. Income tax expense—current 13,000 Income tax payable 13,000 Deferred tax asset 5,000 Income tax expense— deferred 5,000 An additional entry would be prepared by Shin to record an allowance to reduce the deferred tax asset to its realizable value (10% × $20,000 = $2,000). Income tax expense—deferred 2,000 Allowance to reduce deferred tax asset to realizable value 2,000 Based on these three entries, total year 2 income tax expense is $10,000 ($13,000 – $5,000 + $2,000).

(a) Income tax expense is the sum of income taxes currently payable or refundable and the deferred tax expense or benefit which is the change during the year in an enterprise’s deferred tax liabilities and assets. This method is more commonly called the asset and liability approach.

(b) The deferred income tax liability is the result of the undistributed earnings of an equity investee, which are expected to be distributed as dividends in future periods. For accounting purposes, investment revenue is $270,000 ($900,000 × 30%). For tax purposes, dividend revenue is $90,000 ($300,000 × 30%), which will be partially offset by the 80% dividends received deduction. Because of this 80% deduction, the difference ($270,000 −$90,000 = $180,000) is partially a permanent difference (80% × $180,000 = $144,000 which will never be subject to taxes) and partially a temporary difference (20% × $180,000 = $36,000 which will be taxable in future years). This future taxable amount of $36,000 will become taxable after 2010, when the expected tax rate is 25%. Therefore, the deferred tax liability is $9,000 (25% × $36,000). The entry to record the liability is as follows: Income tax expense—deferred 9,000 Deferred tax liability 9,000

(b) The current provision for income taxes is computed by multiplying taxable income on the Form 1120 by the current tax rate. Since taxable income is not given, pretax book income must be adjusted to compute taxable income. Pretax book income $100,000 Excess book depreciation 8,000 Excess book investment revenue [$35,000 −(20% × $25,000)] (30,000) Taxable income $ 78,000 Excess book depreciation is added because it causes book income to be lower than taxable income. For book purposes, investment revenue of $35,000 was recognized using the equity method; for tax purposes, net dividend revenue of $5,000 was recognized [$25,000 −(80% × $25,000)]. The excess book revenue ($35,000 −$5,000 = $30,000) is deducted to compute taxable income. Therefore, the current provision for income taxes is $23,400 ($78,000 × 30%).

(b) Dix did not elect to forego the loss carryback, so $100,000 of the $200,000 loss will be carried back to offset year 1 income, resulting in a tax refund of $40,000 (40% × $100,000). The remaining $100,000 of the year 2 loss will be carried forward to offset part of year 3 income. Thus, the income tax liability at 12/31/Y3 will be $120,000 [40% × ($400,000 −$100,000)].

(c) The warranty temporary difference results in future deductible amounts of $700,000 per year in year 2 through year 4 ($2,100,000 ÷ 3). The installment temporary difference results in future taxable amounts of $500,000 per year in year 2 through year 4 ($1,500,000 ÷ 3). The portions of the resulting deferred tax asset and deferred tax liability that will be netted to find the amount of the current asset/current liability to be presented on the BS are shown below. Deferred tax asset: $(700,000) × 25% = $(175,000) Deferred tax liability: $500,000 × 25% = 125,000 Current deferred tax asset (CDTA) shown on BS $ (50,000) The noncurrent deferred tax asset is $100,000 [25% × ($2,100,000 – $1,500,000)] – $50,000 CDTA.

(c) The warranty temporary difference results in future deductible amounts of $700,000 per year in year 2 through year 4 ($2,100,000 ÷ 3). The installment temporary difference results in future taxable amounts of $500,000 per year in year 2 through year 4 ($1,500,000 ÷ 3). The portions of the resulting deferred tax asset and deferred tax liability that will be netted to find the amount of the current asset/current liability to be presented on the BS are shown below. Deferred tax asset: $(700,000) × 25% = $(175,000) Deferred tax liability: $500,000 × 25% = 125,000 Current deferred tax asset (CDTA) shown on BS $ (50,000) The noncurrent deferred tax asset is $100,000 [25% × ($2,100,000 – $1,500,000)] – $50,000 CDTA.

(d) Deferred tax liabilities and assets are classified as current or noncurrent based on the related asset or liability. A deferred tax liability or asset is considered to be related to an asset or liability if reduction of the asset or liability will cause the temporary difference to reverse. If the deferred tax liability or asset is not related to any asset or liability, then it is classified based on the timing of its expected reversal or utilization date. This deferred tax liability is related to equipment, which is noncurrent, so the deferred tax liability should also be classified as a noncurrent liability. Deferred taxes are always classified as assets or liabilities, rather than as contra accounts.