Question

Sherrod, Inc., reported pretax accounting income of $78 million for 2021. The following information relates to differences between pretax accounting income and taxable income:

1. Income from installment sales of properties included in pretax accounting income in 2021 exceeded that reported for tax purposes by $3 million. The installment receivable account at year-end 2021 had a balance of $4 million (representing portions of 2020 and 2021 installment sales), expected to be collected equally in 2022 and 2023.
2. Sherrod was assessed a penalty of $4 million by the Environmental Protection Agency for violation of a federal law in 2021. The fine is to be paid in equal amounts in 2021 and 2022.
3. Sherrod rents its operating facilities but owns one asset acquired in 2020 at a cost of $72 million. Depreciation is reported by the straight-line method, assuming a four-year useful life. On the tax return, deductions for depreciation will be more than straight-line depreciation the first two years but less than straight-line depreciation the next two years ($ in millions):

	Income Statement					Tax Return					Difference
2020		$	18				$	23				$	(5	)
2021			18					29					(11	)
2022			18					11					7
2023			18					9					9
		$	72				$	72				$	0

4. For tax purposes, warranty expense is deducted when costs are incurred. The balance of the warranty liability was $2 million at the end of 2020. Warranty expense of $4 million is recognized in the income statement in 2021. $3 million of cost is incurred in 2021, and another $3 million of cost anticipated in 2022. At December 31, 2021, the warranty liability is $3 million (after adjusting entries).
5. In 2021, Sherrod accrued an expense and related liability for estimated paid future absences of $8 million relating to the company’s new paid vacation program. Future compensation will be deductible on the tax return when actually paid during the next two years ($5 million in 2022; $3 million in 2023).
6. During 2020, accounting income included an estimated loss of $4 million from having accrued a loss contingency. The loss is paid in 2021, at which time it is tax deductible.

Balances in the deferred tax asset and deferred tax liability accounts at January 1, 2021, were $1.5 million and $1.5 million, respectively. The enacted tax rate is 25% each year.

Required:
1. Determine the amounts necessary to record income taxes for 2021, and prepare the appropriate journal entry.
2. What is the 2021 net income?
3. Show how any deferred tax amounts should be classified and reported in the 2021 balance sheet.

only answer for question 3

Answer 1

Answer 1

Event	Particulars	Amounts	Hint
	Pretax accounting income (As per given)	$          78
B	Add: Permanent difference in fine	$             4
	Pretax accounting income adjusted with Permanent difference	$          82
A	Less: excess from installment sales	$          (3)	Deferred tax liability
C	Less: excess tax depreciation	$        (11)	Deferred tax liability
D	Add: excess warranty expense (4-3)	$             1	Deferred tax asset
E	Add: expense for future absences	$             8	Deferred tax asset
F	Less: loss contingency reversal	$          (4)	Reversal of deferred tax asset
	Taxable Income	$          73

Date	General Journal	Debit	Credit
Dec 31, 2021	Tax Expenses (82*25%)	$    20.50
	Deferred tax asset ((1+8-4)*25%)	$       1.25
	Deferred tax liability ((3+11)*25%)		$             3.50
	Taxes payable (73*25%)		$           18.25
	(To record Income tax expense.)

Answer 2

Income statement
Pretax accounting income (As per given)			$           78.00
Less: Tax expense (As per above entry)			$           20.50
Net Income			$           57.50

Answer 3

Event	Remarks		Amounts
A	From the Installment Receivable
	Current deferred tax liability (Year 2022 = 2*25%)		$       0.50
	Non-current deferred tax liability (Year 2023 = 2*25%)		$       0.50
B	Not Applicable
C	From the Depreciation
	Non-current deferred tax liability (For Year 2022 & 2023 = ((18+18-11-9)*25%)		$       4.00
D	From the Warranty
	Current deferred tax asset (3*25%)		$       0.75
E	Expense for future absences
	Current deferred tax asset (Year 2022 = 5*25%)		$       1.25
	Non-current deferred tax asset (Year 2023 = 3*25%)		$       0.75
F	Not Applicable
	Current:
	Deferred tax asset (0.75+1.25)		$       2.00
	Deferred tax liability		$       0.50
	Net Current Deferred Tax Asset (2-0.5)		$       1.50
	Non-Current:
	Deferred tax asset		$       0.75
	Deferred tax liability (0.50+4)		$       4.50
	Net Noncurrent Deferred Tax Liability (4.50-0.75)		$       3.75
	Net Current Deferred Tax Asset (2-0.5)		$       1.50
	Net Noncurrent Deferred Tax Liability (4.50-0.75)		$       3.75
	Net Deferred Tax Liability (3.75-1.50)		$       2.25