Income Taxes

E 16-1 Temporary difference; taxable income given LO1
Alvis Corporation reports pretax accounting income of $400,000, but due to a single temporary difference, taxable income is only $250,000. At the beginning of the year, no temporary differences existed.
Required:
1. Assuming a tax rate of 35%, what will be Alvis's net income?
2. What will Alvis report in the balance sheet pertaining to income taxes?

Solution:
Requirement 1
Since taxable income is less than pretax accounting income, a future taxable amount will occur when the temporary difference reverses. This means a deferred tax liability should be recorded to reflect the future tax consequences of the temporary difference.

------------------------------------------------- ------------------------------------------------- Income tax expense (to balance) 140,000 Deferred tax liability ([$400,000 - 250,000] x 35%) 52,500 Income tax payable ($250,000 x 35%) 87,500

As a result, net income is $260,000:

Pretax accounting income $400,000 Income tax expense 140,000 Net income $260,000 Requirement 2 In its balance sheet, Alvis will report the $52,500 deferred tax liability among either its current or long-term liabilities depending on the cause of the temporary difference and the $87,500 income tax payable as a current liability.
-------------------------------------------------

E 16-2 Determine taxable income; determine prior year deferred tax amount LO1
On January 1, 2008, Ameen Company purchased a building for $36 million. Ameen uses straight-line depreciation for financial statement reporting and MACRS for income tax reporting. At December 31, 2010, the carrying value of the building was $30 million and its tax basis was $20 million. At December 31, 2011, the carrying value of the building was $28 million and its tax basis was $13 million. There were no other temporary differences and no permanent differences. Pretax accounting income for 2011 was $45 million.
Required:
1. Prepare the appropriate journal entry to record Ameen's 2011 income taxes. Assume an income tax rate of 40%.
2. What is Ameen's 2011 net income?

Solution:
Requirement 1
-------------------------------------------------

($ in millions) Current Future Year Taxable 2011 Amount [total]
-------------------------------------------------
Pretax accounting income 45
Temporary difference: Depreciation ($30 – 20) – ($28 – 13) = (5) 15 ($28 – 13)

Taxable income (tax return) 40

Enacted tax rate 40% 40% Tax payable currently 16 Deferred tax liability 6
-------------------------------------------------

------------------------------------------------- Deferred tax liability:
-------------------------------------------------
Ending balance (balance currently needed) $ 6 Less: beginning balance ($30 – 20) x 40% (4) Change needed to achieve desired balance $ 2
-------------------------------------------------

------------------------------------------------- Journal entry at the end of 2011
-------------------------------------------------
Income tax expense (to balance) 18 Deferred tax liability (determined above) 2 Income tax payable (determined above) 16
-------------------------------------------------

Requirement 2 ($ in millions) Pretax income $45 Income tax expense (18) Net income $27

-------------------------------------------------

E 16-4 Temporary difference; income tax payable given LO2
In 2011, DFS Medical Supply collected rent revenue for 2012 tenant occupancy. For income tax reporting, the rent is taxed when collected. For financial statement reporting, the rent is recognized as income in the period earned. The unearned portion of the rent collected in 2011 amounted to $300,000 at December 31, 2011. DFS had no temporary differences at the beginning of the year.
Required: Assuming an income tax rate of 40% and 2011 income tax payable of $950,000, prepare the journal entry to record income taxes for 2011.

Solution:

------------------------------------------------- ------------------------------------------------- Income tax expense (to balance) 830,000 Deferred tax asset ($300,000 x 40%) 120,000 Income tax payable (given) 950,000

-------------------------------------------------

E 16-11 Deferred tax asset; income tax payable given; previous balance in valuation allowance LO3 (This is a variation of Exercise 16-10, modified to assume a previous balance in the valuation allowance.)
At the end of 2010, Payne Industries had a deferred tax asset account with a balance of $30 million attributable to a temporary book-tax difference of $75 million in a liability for estimated expenses. At the end of 2011, the temporary difference is $70 million. Payne has no other temporary differences. Taxable income for 2011 is $180 million and the tax rate is 40%.
Payne has a valuation allowance of $10 million for the deferred tax asset at the beginning of 2011.
Required:
1. Prepare the journal entry(s) to record Payne's income taxes for 2011, assuming it is more likely than not that the deferred tax asset will be realized.
2. Prepare the journal entry(s) to record Payne's income taxes for 2011, assuming it is more likely than not that one-half of the deferred tax asset will ultimately be realized.
Solution:
Requirement 1
-------------------------------------------------
($ in millions)
-------------------------------------------------
Current Future Year Deductible 2011 Amounts
-------------------------------------------------
Temporary difference: (70)

Taxable income 180
Enacted tax rate 40% 40% Tax payable currently 72 Deferred tax asset (28)
-------------------------------------------------

------------------------------------------------- Deferred tax asset:
-------------------------------------------------
Ending balance (balance currently needed) $ 28 Less: beginning balance ($75 x 40%) (30) Change needed to achieve desired balance $( 2)
-------------------------------------------------

------------------------------------------------- Journal entries at the end of 2011
-------------------------------------------------
Income tax expense (to balance) 74 Deferred tax asset (determined above) 2 Income tax payable (determined above) 72 Valuation allowance – deferred tax asset 10 Income tax expense 10
-------------------------------------------------
Of course, these two entries can be combined.
-------------------------------------------------

Requirement 2
-------------------------------------------------
($ in millions)
-------------------------------------------------
Income tax expense (to balance) 74 Deferred tax asset (determined above) 2 Income tax payable (determined above) 72

Income tax expense 4 Valuation allowance – deferred tax asset ([1/2 x $28] – $10) 4
-------------------------------------------------
Of course, these two entries can be combined.
-------------------------------------------------

E 16-13
Multiple differences; calculate taxable income LO1 LO4
Southern Atlantic Distributors began operations in January 2011 and purchased a delivery truck for $40,000. Southern Atlantic plans to use straight-line depreciation over a four-year expected useful life for financial reporting purposes. For tax purposes, the deduction is 50% of cost in 2011, 30% in 2012, and 20% in 2013. Pretax accounting income for 2011 was $300,000, which includes interest revenue of $40,000 from municipal bonds. The enacted tax rate is 40%.
Required:
Assuming no differences between accounting income and taxable income other than those described above:
1. Prepare the journal entry to record income taxes in 2011.
2. What is Southern Atlantic's 2011 net income?

Solution:
Requirement 1
-------------------------------------------------
($ in thousands) Current Future Year Taxable 2011 Amounts
-------------------------------------------------

------------------------------------------------- Pretax accounting income 300
Permanent difference: Municipal bond interest (40)
Temporary difference: Depreciation (10) 10

Taxable income (income tax return) 250 Enacted tax rate 40% 40% Tax payable currently 100 Deferred tax liability 4
-------------------------------------------------

------------------------------------------------- Deferred tax liability:
-------------------------------------------------
Ending balance (balance currently needed) $ 4 Less: beginning balance 0 Change needed to achieve desired balance $ 4
-------------------------------------------------

------------------------------------------------- Journal entry at the end of 2011
-------------------------------------------------
Income tax expense (to balance) 104 Deferred tax liability (determined above) 4 Income tax payable (determined above) 100
-------------------------------------------------

Requirement 2 ($ in thousands) Pretax income $300 Income tax expense (104)
-------------------------------------------------
Net income $196 E 16-15 Multiple tax rates LO2 LO5
Allmond Corporation, organized on January 3, 2011, had pretax accounting income of $14 million and taxable income of $20 million for the year ended December 31, 2011. The 2011 tax rate is 35%. The only difference between accounting income and taxable income is estimated product warranty costs. Expected payments and scheduled tax rates (based on recent tax legislation) are as follows:

Required:
1. Determine the amounts necessary to record Allmond's income taxes for 2011 and prepare the appropriate journal entry.
2. What is Allmond's 2011 net income?

Solution :
Requirement 1
-------------------------------------------------
($ in millions)
-------------------------------------------------
Current Future Year Deductible 2011 Amounts Total 2012 2013 2014 2015
-------------------------------------------------
Pretax accounting income 14
Temporary difference: Warranty expense 6 (2) (1) (1) (2)

Taxable income (tax return) 20
Enacted tax rate 35% 30% 30% 30% 25% Tax payable currently 7 Deferred tax asset (0.6) (0.3) (0.3) (0.5) (1.7)
-------------------------------------------------

------------------------------------------------- Deferred tax asset:
-------------------------------------------------
Ending balance (balance currently needed) $ 1.7 Less: beginning balance (0.0) Change needed to achieve desired balance $1.7
-------------------------------------------------

------------------------------------------------- Journal entry at the end of 2011
-------------------------------------------------
Income tax expense (to balance) 5.3 Deferred tax asset (determined above) 1.7 Income tax payable (determined above) 7.0
-------------------------------------------------

Requirement 2 ($ in millions) Pretax income $14.0 Income tax expense (5.3) Net income $ 8.7
E 16-20 Operating loss carryforward LO7
During 2011, its first year of operations, Baginski Steel Corporation reported an operating loss of $375,000 for financial reporting and tax purposes. The enacted tax rate is 40%.
Required:
1. Prepare the journal entry to recognize the income tax benefit of the operating loss. Assume the weight of available evidence suggests future taxable income sufficient to benefit from future deductible amounts from the operating loss carryforward.
2. Show the lower portion of the 2011 income statement that reports the income tax benefit of the operating loss.

Solution:
Requirement 1 Because the loss year is the company’s first year of operations, the carryback option is unavailable. The loss is carried forward.

------------------------------------------------- ($ in thousands) Current Future Year Deductible 2011 Amounts [total]
-------------------------------------------------
Operating loss (375) Loss carryforward 375 (375) 0
Enacted tax rate 40% 40% Tax payable 0 Deferred tax asset (150)
-------------------------------------------------

------------------------------------------------- Deferred tax asset:
-------------------------------------------------
Ending balance (balance currently needed) $ 150 Less: beginning balance (0) Change needed to achieve desired balance $150
-------------------------------------------------

------------------------------------------------- Journal entry at the end of 2011
-------------------------------------------------
Deferred tax asset (determined above) 150 Income tax benefit – operating loss (to balance) 150

Since the weight of available evidence suggests future taxable income sufficient to benefit from future deductible amounts from the operating loss carryforward, no valuation allowance is needed.
Requirement 2

------------------------------------------------- ($ in thousands) Operating loss before income taxes $375 Less: Income tax benefit – operating loss (150) Net operating loss $225

-------------------------------------------------

E 16-21 Operating loss carryback LO7
Wynn Sheet Metal reported an operating loss of $100,000 for financial reporting and tax purposes in 2011. The enacted tax rate is 40%. Taxable income, tax rates, and income taxes paid in Wynn's first four years of operation were as follows:

Required:
1. Prepare the journal entry to recognize the income tax benefit of the operating loss. Wynn elects the carryback option.
2. Show the lower portion of the 2011 income statement that reports the income tax benefit of the operating loss.

Solution:
Requirement 1

------------------------------------------------- ($ in thousands) Current Prior Years Year 2009 2010 2011 ------------------------------------------------- Operating loss (100) Loss carryback (80) (20) 100 0
Enacted tax rate 40% 45% 40% Tax payable (refundable) (32) (9) 0
-------------------------------------------------

------------------------------------------------- Journal entry at the end of 2011
-------------------------------------------------
Receivable – income tax refund ($32 + 9) 41 Income tax benefit – operating loss 41

Requirement 2

------------------------------------------------- ($ in thousands) Operating loss before income taxes $100 Less: Income tax benefit from loss carryback (41) Net operating loss $ 59

-------------------------------------------------

E 16-22 | | Operating loss carryback and carryforward | | LO7 |

(This exercise is based on the situation described in the previous exercise, modified to include a carryforward in addition to a carryback.) Wynn Sheet Metal reported an operating loss of $160,000 for financial reporting and tax purposes in 2011. The enacted tax rate is 40%. Taxable income, tax rates, and income taxes paid in Wynn's first four years of operation were as follows:

Required: 1. | | Prepare the journal entry to recognize the income tax benefit of the operating loss. Wynn elects the carryback option. | 2. | | Show the lower portion of the 2011 income statement that reports the income tax benefit of the operating loss. |

Solution:
Requirement 1
-------------------------------------------------

($ in thousands) Current Future Prior Years Year Deductible 2009 2010 2011 Amounts [total]
-------------------------------------------------
Operating loss (160) Loss carryback (80) (60) 140 Loss carryforward 20 (20) 0
Enacted tax rate 40% 45% 40% 40% Tax payable (refundable) (32) (27) 0 Deferred tax asset (8)
-------------------------------------------------

------------------------------------------------- Deferred tax asset:
-------------------------------------------------
Ending balance (balance currently needed) $ 8 Less: beginning balance (0) Change needed to achieve desired balance $8
-------------------------------------------------

------------------------------------------------- Journal entry at the end of 2011
-------------------------------------------------
Receivable – income tax refund ($32 + 27) 59 Deferred tax asset (determined above) 8 Income tax benefit – operating loss (to balance) 67

Requirement 2

------------------------------------------------- ($ in thousands) Operating loss before income taxes $160 Less: Income tax benefit: Tax refund from loss carryback $59 Future tax savings from loss carryforward 8 (67) Net operating loss $ 93