Question

Problem - 3 (Five Differences, Compute Taxable income and Deferred Taxes, Draft Income Statement) Wise Company began operations at the beginning of 2015. The following information pertains to this company. 1. Pretax financial income for 2015 is $100,000. 2. The tax rate enacted for 2015 and future years is 40%. 3. Differences between the 2015 income statement and tax return are listed below: (a) Warranty expense accrued for financial reporting purposes amounts to $7,000. Warranty deduc- tions per the tax return amount to $2,000. (b) Gross profit on construction contracts using the percentage-of-completion method per books amounts to $92,000. Gross profit on construction contracts for tax purposes amounts to $67,000. (0) Depreciation of property, plant, and equipment for financial reporting purposes amounts to $60,000. Depreciation of these assets amounts to $80,000 for the tax return. (d) A $3,500 fine paid for violation of pollution laws was deducted in computing pretax financial income. (e) Interest revenue recognized on an investment in tax-exempt municipal bonds amounts to $1,500. 4. Taxable income is expected for the next few years. (Assume (a) is short-term in nature; assume (b) and (c) are long-term in nature.) Instructions (a) Compute taxable income for 2015. (b) Compute the deferred taxes at December 31, 2015, that relate to the temporary differences described above. Clearly label them as deferred tax asset or liability. (c) Prepare the journal entry to record income tax expense, deferred taxes, and income taxes payable for 2015. (d) Draft the income tax expense section of the income statement, beginning with "Income before income taxes."

Answer 1

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Answer-

a. Compute taxable income for 2015 100000 Pretax financial income Permanent differences: Fine for pollution Tax-exempt interest 3500 -1500 5000 Originating temporary differences: Excess warranty expense per books ($7,000-$2,000) Excess construction profits per books ($92,000 - $67,000) Excess depreciation per tax return ($80,000 - $60,000) Taxable income -25000 20000 102000

b. Compute the deferred taxes at December 31,2015, that relate to the temporary differences describet above. Clearly label them as deferred tax asset or liability Tax Deferred Tax (Asset) Liability -2000 Temporary Difference Future Taxable (Deductible) Amounts Warranty costs -5000 Construction profits 25000 Depreciation 20000 Totals 40000 Rate 40% 40% 40% 10000 8000 -2000 18000 *Because of a flat tax rate, these totals can be reconciled: $40,000 X 40% = $(2,000) + $18,000

c. Prepare the journal entry to record income tax expense, deferred taxes, and income taxes payable for 2015 40800 2000 Income Tax Expense a/c Dr. Deferred Tax Asset a/c Dr. To Deferred Tax Liability To Income Tax Payable 18000 24800 Taxable income for 2015 (answer part (a)] Tax rate Income tax payable for 2015 62000 40% 24800 18000 Deferred tax liability at the end of 2015 [part (b)] Deferred tax liability at the beginning of 2015 Deferred tax expense for 2015 0 18000 2000 Deferred tax asset at the end of 2015 Deferred tax asset at the beginning of 2015 Deferred tax benefit for 2015 0 -2000 Deferred tax expense for 2015 Deferred tax benefit for 2015 Net deferred tax expense for 2015 18000 -2000 16000 24800 Current tax expense for 2015 (Income tax payable) Deferred tax expense for 2015 Income tax expense for 2015 16000 40800

d. Draft the income tax expense section of the income statement begining with "Income 100000 Income before income taxes Income tax expense Current Deferred Net income 24800 16000 40800 59200