Question

Chapter 16-Problem 10

Tru Developers, Inc. sells plots of land for industrial development. Tru recognizes income for financial reporting purposes in the year it sells the plots. For some of the plots sold this year, Tru took the position that it could recognize the income for tax purposes when the installments are collected. Income that Tru recognized for financial reporting purposes in 2018 for plots in this category was $60 million. The company expected to collect 60% of each sale in 2019 and 40% in 2020. This amount over the next two years is as follows:

2019              $36 million

2020                24 million

                       $60 million

                       =========

Tru’s pretax accounting income for 2018 was $90 million. In its income statement, Tru reported interest income of $20 million, unrelated to the land sales, for which the company’s position is that the interest is not taxable. Accordingly, the interest was not reported on the tax return. There are no differences between accounting income and taxable income other than those described above. The enacted tax rate is 40 percent.

Management believes the tax position taken on the land sales has a greater than 50% chance of being upheld based on its technical merits, but the position taken on the interest has a less than 50% chance of being upheld. It is further believed that the following likelihood percentages apply to the tax treatment of the land sales ($ in millions):

                           Amount qualifying for                                                   Percentage Likelihood of

                     Installment Sales Treatment                                           Tax Treatment Being Sustained

                                      $ 60                                                                                         20%

                                         50                                                                                         20%

                                         40                                                                                         20%

                                         30                                                                                         20%

                                         20                                                                                         20%

Required:

1. What portion of the tax benefit of tax-free interest will Tru recognize on its 2018 tax return?
2. What portion of the tax benefit of tax-free interest will Tru recognize on its financial statements?

3-a. what portion of the tax on the $60 million income from the plots sold on an installment basis will Tru defer on its 2018 tax return?

3-b.   What portion of the tax on the $60 million income from the plots sold on an installment basis will Tru defer in its 2018 financial statements?

4. Prepare the journal entry to record income taxes in 2018 assuming full recognition of the tax benefits in the financial statements of both differences pretax accounting income and taxable income.
5. Prepare the journal entry to record income taxes in 2018 assuming the recognition of the tax benefits in the financial statements you indicated in requirements 1-3.

What portion of the tax benefit of tax-free interest will Tru recognize on its 2018 tax return and financial statements? What portion of the tax on the $60 million income from the plots sold on an installment basis will Tru defer on its 2018 tax return and financial statements?

1	Tax benefit recognized		million
2	Tax benefit recognized		million
3a	Amount deferred		million
3b			million

Prepare the journal entry to record income taxes in 2018 assuming full recognition of the tax benefits in the financial statements of both differences between pretax accounting income and taxable income. (If no entry is required for a transaction/event, type “No journal entry required” in the first account field. Enter your answers in millions (i.e., 10,000,000 should be entered as 10).) Prepare the journal entry to record income taxes in 2018 assuming the recognition of the tax benefits in the financial statements you indicated in requirements 1-3.

Event	General Journal	Debit	Credit
1

Answer 1

Part 1

Tax benefit recognized

$8 million

Tax benefit = tax free interest income*tax rate = $20million * 40% = $8 million

Part 2

Tax benefit recognized

$0

$0 tax benefit is recognized as it is not most likely that Tru's position that the interest is not taxable, could be sustained. The liability of $6 million should be recorded. This should be reported as long-term liability.

Part 3 A

Amount deferred

$24 million

Amount deferred = $60 million X 40% = $24 million (as Tru is completely reducing taxable income by $50 million because of the tax treatments of the plot sales)

Part 3 B

Amount deferred

$20 million

Part 4

Amount Qualifying For Installment Sales Treatment	Percentage Likelihood of Tax Treatment Being Sustained	Cumulative Likelihood of Tax Treatment Being Sustained
60	20%	20%
50	20%	40%
40	20%	60%
30	20%	80%
20	20%	100%

It is most likely that Tru's position could be maintained and it needs to estimate the largest amount that has a greater than 50% probability.

Amount deferred = 60*40% = 24

Part 4

General journal	Debit	Credit
Income tax expense (90*40%)	36
Deferred tax liability (60*40%)		24
Income tax payable		12

Part 5

Part 5

General journal	Debit	Credit
Income tax expense	40
Deferred tax liability (40*40%)		16
Income tax payable (20*40%)		8
Liability-potential additional tax (8+((60-40)*40%))		16

General journal	Debit	Credit
Income tax expense (100*40%)	40
Deferred tax liability (50*40%)		20
Income tax payable (15*40%)		6
Liability-potential additional tax (6+((70-50)*40%)		14