Question

You assumed the role of accounting manager at Big Fish Industries. Your CFO has asked you to provide input on the company's income tax position based on the following: 1. Pretax accounting income was $61 million for the year ended December 31, 2018, $75 million for the year ended December 31, 2019, and $52 million for the year ended December 31, 2020. 2. The differences between pretax income and taxable income relate to the following items: a. Tax depreciation exceeds book depreciation by $30 million in 2018 for the business complex acquired that year. This amount is scheduled to be $60 million in 2019 and to reverse as ($50 million) and ($40 million) in 2020 and 2021 respectively. b. Company general insurance coverages are typically paid in the year prior to usage. This policy began in 2018. Thus the 2020 insurance coverage is paid for in 2019. Amounts paid during each year are as follows: i. 2018- $16 million ($6 million for 2018 coverage and $10 million for 2019 coverage) ii. 2019-$9 million for 2020 coverage iii. 2020-$11 million for 2021 coverage c. A $6 million loss contingency was accrued in 2018, to be paid in 2019. 3. No temporary differences existed at the company prior to these years besides the items that are addressed above. 4. The currently enacted tax rate is 20% Required: • Determine taxable income for 2018, 2019 and 2020 • Prepare the appropriate journal entry to record income tax expense for these three years

Answer 1

Deferred Tax Liability / Asset - Few expenses or income disallowed for tax basis of accounting as compared to books of accounts. In such case, pre-tax income will be either more or less as compared to accounting income. If accounting income is more compared to taxable income, this leads to future taxable amount and if accounting income is less compared to taxable income, this leads to future deductible amount. Future taxable amount gets accounted under Deferred Tax Liability and future deductible amount under Deferred Tax Asset account. Income tax expense will be accounted for the accounting income and tax liability will be accounted only for taxable income and thus difference will gets accounted either as deferred tax liability or asset as appropriately.

For example, in the said question, tax depreciation is more by $30Mn in year 2018 as compared to accounting income. This results in more accounting income as compared to taxable income, because if expense are more, net income reduces. Hence tax oblige to pay in year 2018 will be less as compared to tax expense, which results in future taxable amount. Thus the difference gets accounted in Deferred tax liability.

Thus, multiple differences are to be considered to arrive at deferred tax liability or asset. With that said, here's the table showing computation of taxable income and journal entries for year 2018,2019 and 2020:

Year 2018 Year 2019 Year 2020 Accounting Tax basis | Accounting | Tax basis Accounting Tax basis ||$ 61,000,000.00 $ 61,000,000.00 || $ 75,000,000.00 $ 75,000,000.00||$ 52,000,000.00 $ 52,000,000.00 Year 2021 Year 2021 Pre tax income Add/(minus): Permanent Difference (Income) / Expense ||$61,000,000.00 $ 61,000,000.00||$75,000,000.00 $ 75,000,000.00 $ 52,000,000.00 $ 52,000,000.00 || $ (30,000,000.00)| $ 50,000,000.00||$ 40,000,000.00 S (9,000,000.00) $ (11,000,000.00) $ 11,000,000.00 Pre tax income after adjustment Add/(minus): Temporary Difference (Income) / Expense (Future dedutible amount) / Future taxable amount Depreciation Insurance Premium payment Insurance Premium paid in advance reversed Contingency Loss Taxable income (Pre tax income after adjustment "Add/(minus)" temporary difference) Tax Rate Tax payable Difference to be accounted for Opening Balance in Deferred Tax (Liability) / Asset Closing Balance $ 10,000,000.00 || $ 16,000,000.00) ||$ 61,000,000.00 $ 35,000,000.00 ||$ 75,000,000.00 20% 20% 20% | $ 12,200,000.00 $ 7,000,000.00 || $ 15,000,000.00 ||$ 5,200,000.00) ||$(11,000,000.00) I $ | $ (5,200,000.00) IS (5,200,000.00) $(16,200,000.00) $(60,000,000.00) $(10,000,000.00) $ 9,000,000.00 $ 6,000,000.00 $ 20,000,000.00 20% $ 4,000,000.00 $ 52,000,000.00 20% $ 10,400,000.00 $ 10,400,000.00 $(16,200,000.00) $ (5,800,000.00 $ 104,000,000.00||$ 29,000,000.00 20% 20% $ 20,800,000.00||$ 5,800,000.00 $ 5,800,000.00 ||$ (5,800,000.00) ||$ ||$ 12,200,000.00 Journal Entry for 2018: Dr. Income Tax Expense Cr. Deferred Tax Liability Cr. Income Tax Payable (To Record Income tax Expense for year 2018) $ $ 5,200,000.00 || 7,000,000.00 || IS 15,000,000.00 Joumal Entry for 2019: Dr. Income Tax Expense Cr. Deferred Tax Liability Cr. Income Tax Payable (To record Income tax expense for year 2019) $ 11,000,000.00 $ 4,000,000.00 Journal Entry for 2020: Dr. Income Tax Expense Deferred Tax Liability Cr. Income Tax Payable (To record Income tax expense for year 2020) ||$ 10,400,000.00 ||$ 10,400,000.00 $ 20,800,000.00 || Thus, Deferred Tax Asset/(Liability) account computation: | Year 2018 Year 2019 Year 2020 ||$ 5,200,000.00 Cr ||$ 11,000,000.00 Cr ||$ 10,400,000.00 Dr ||$ 5,800,000.00 C ||$ 5,800,000.00 Dr I $ Balance adjusted in year 2021 (If there are no other adjustments)