Question

A corporation has pretax financial accounting (book) income of $146,000 in year 3. Additional information (for year 3) is as follows: 1. Municipal bond interest income is $35,000. 2. Life insurance premium expense, where the corporation is the beneficiary per books is $4,000. 3. Accelerated depreciation is used for tax purposes, while straight-line is used for books. Tax depreciation is $10,000; book depreciation is $5,000. 4. Estimated warranty expense of $500 is accrued for book purposes. Additional details that may affect amounts in Year 3-Year 5 a. On 1/1/Y1 the enterprise acquired a depreciable asset for $30,000 that had an estimated life of six years and is depreciated on a straight-line basis for book purposes. For tax purposes, the asset is depreciated using the straight-line election under MACRS and qualifies as a three-year asset. The depreciation for each year under MACRS is as follows: (Year 1 $5,000; Year 2 $10,000; Year 3 $10,000; Year 4 $5,000) b. The enterprise deducted warranty expense of $500 for book purposes in year 3 that is expected to be deductible for tax purposes in year 4. c. Taxable income was $112,000 in Year 4, and $113,500 in Year 5. d. The applicable tax rate is 40% for all years affected. Required: i. Complete the following helper schedule for depreciation and warranty cost. Yr 1 Yr 2 Yr 3 Book depreciation 5.000 5,000 5,000 Tax depreciation 5,000 10.000 10,000 Yr 4 5,000 5,000 Yr 5 5,000 DTI ii. Determine taxable income for Year 3 and prepare the necessary income tax related journal entry (entries). Pretax financial income $146,000 1 municipal bond (35,000) 4,000 Insurance expense 3 Depreciation - 5 -10 (5,000) "500 - Warranty expense Taxable income 110.500 DI ב בה

Answer 1

Answer (i):

Year 1 Book Depreciation $5,000 Tax Depreciation | $5,000 2 $5,000 $10,000 3 $5,000 $10,000 4 $5,000 $5,000 5 $5,000 $0

Answer (ii):

Calculation of taxable income for year 3 and related journal entry are as follows:

Pretax financial Income 1 Municipal bond interest 2 Insurance Premuim 3 Difference in Tax and book depreciation 4 Warranty Expense $146,000 ($35,000) $4,000 ($5,000) $500 Taxable Income $110,500 Credit Debit $46,000 $200 Date Account Title and explanation Dec. 31, Year 3 Income Tax Expense Deferred Tax Asset Income Tax Payable Deferred Tax Liability (to record income tax expense and payable) $44,200 $2,000

Calculations:

Income tax payable = Taxable income * Tax rate = 110500 * 40% = $44,200

Municipal interest and insurance premium are permanent differences.

Deferred tax liability = Differential tax depreciation * tax rate = 5000 * 40% = $2,000

Deferred tax asset = estimated warranty expenses * 40% = 500 * 40% = $200