Question

(Deferred Tax Liability, Change in Tax Rate, Prepare Section of Income Statement) Novotna Inc.’s only temporary difference at the beginning and end of 2016 is caused by a $3 million deferred gain for tax purposes for an install- ment sale of a plant asset, and the related receivable (only one-half of which is classified as a current asset) is due in equal install- ments in 2017 and 2018. The related deferred tax liability at the beginning of the year is $1,200,000. In the third quarter of 2016, a new tax rate of 34% is enacted into law and is scheduled to become effective for 2018. Taxable income for 2016 is $5,000,000, and taxable income is expected in all future years.

Instructions

1. (a) Determine the amount reported as a deferred tax liability at the end of 2016. Indicate proper classification(s).

2. (b) Prepare the journal entry (if any) necessary to adjust the deferred tax liability when the new tax rate is enacted into law.

3. (c) Draft the income tax expense portion of the income statement for 2016. Begin with the line “Income before income

   taxes.” Assume no permanent differences exist.

Answer 1

Novotna Inc. Requirement a Future Years 2017 2018 1500000 1500000 34% 34% 510000 510000 Total 3000000 Future taxable (deductible) amounts Tax rate Deferred tax liability (asset) 1020000 The prior tax rate of 34% is computed by dividing the $1,200,000 balance of the deferred tax liability account at January 1, 2016, by the $3,000,000 cumulative temporary difference at that same date. Related Balance Sheet Account Classification Resulting Deferred Tax (Asset) Liability 510000 510000 Installment Receivable Installment Receivable Current Noncurrent One-half of the installments receivable is classified as a current asset and one-half is noncurrent. Therefore, the deferred tax liability related to the portion of the receivable coming due in 2016 is current and the deferred tax liability balance related to the portion of the receivable coming due in 2018 is noncurrent. Requirement b Dr. 180000 Deferred Tax Liability a/c To Income Tax Expense 180000 There are no changes during 2016 in the cumulative temporary difference. The entire change in the deferred tax liability account is due to the change in the enacted tax rate. That change is computed as follows: Deferred tax liability at the end of 2016 (computed in (a)) 1020000 Deferred tax liability at the beginning of 2016 1200000 Deferred tax benefit for 2016 due to change in enacted tax rate (decrease in deferred -180000 tax liability required) Requirement 5000000 Income before income taxes Income tax expense Current Adjustment due to change in tax rate Net income 1700000 -180000 1520000 3480000 Pretax financial income is equal to the taxable income for 2016 because there were no changes in the cumulative temporary difference and no permanent differences. Taxable income for 2016 Tax rate for 2016 (computed in (a)) Current tax expense 5000000 34% 1700000 Current tax expense for 2016 would also need to be recorded. The entry would be a debit to Income Tax Expense and a credit to Income Tax Payable for $1,700,000.