Question

1. The following information is available for the first three years of operations for Santos Inc.:

1. Year           Earnings Before Tax

            2020                   $670,000

            2021                     715,000

2. Depreciation of property, plant and equipment for financial reporting purposes amounts to $60,000 each year for 2020-2022. The company is able to deduct the full cost under the IRS Code Section 179 $180,000 amount allowed for tax purposes in 2020 (note there is no tax depreciation in future years).

3. On October 1, 2020, $360,000 was collected in advance for rental of a building for a two-year period October 1, 2020 – September 30, 2022. The entire $360,000 was reported as taxable income in 2020. The company uses the accrual basis of accounting for financial statement purposes.

4. Santos Inc. insures the lives of its chief executives every year. The annual payment is $12,000 and this amount is included as an expense on the income statement each year.

5. The company sells its merchandise on an installment contract basis. In 2020, Santos Inc. reported gross profit of $220,000 tax purposes, and $420,000 for financial statement purposes. This will result in taxable amounts of $100,000 in each of the next two years.

6. Interest recognized on tax-exempt municipal bonds amounts are fixed and will be $20,000 each year in 2020, 2021 and 2022.

7. Warranty expense accrued for financial reporting was $26,000 in 2020. Warranty deductions on the tax returns are $14,000 in 2020, $9,000 in 2021 and $3,000 in 2022.

8. In 2021 Thompson Inc. recorded a $45,000 accrual for litigation liability which will be paid in 2022.

1. The enacted tax rates existing at December 31, 2020 are 30% for 2020 and 34% for 2021 and thereafter.

Instructions

1. Complete the worksheet provided. It includes the following.
   1. Prepare a reconciliation of Book Income to Taxable Income for 2020.
   2. Prepare a schedule of future taxable and (deductible) amounts at the end of 2020.
   3. Prepare a schedule of the deferred tax (asset) and liability at the end of 2020.
   4. Prepare the journal entry to record income tax expense, deferred income taxes, and income tax payable for 2020.
2. Show how the deferred income taxes should be reported on the Balance Sheet at December 31, 2020.
3. Show how the taxes should be reported on the Income Statement at December 31, 2020.
4. Repeat a. to f. above for 2021.

Answer 1

(a) (i) Reconciliation of Book Income to Taxable Income for 2020
Particulars	$
Earning before tax as per book	6,70,000
Add: Depreciation as per accounts	60,000
Less: Depreciation as per Tax Law	-1,80,000
Less: Rent income reported in accounts (360000/24*3)	-45,000
Add: Rent income taxed as per Tax Law	3,60,000
Add: Insurance expenses for chief executive is not deductible under tax law	12,000
Less: Gross profit as per financial reporting (Accounts)	-4,20,000
Add: Gross profit as per Tax Law	2,20,000
Less: Interest (Tax free bond)	-20,000
Add: Warranty expenses as per accounts	26,000
Less: Warranty expenses as per Tax Laws	-14,000
Taxable Income	6,69,000
Current Tax @ 30%	2,00,700
(iii)
Item influencing DTA
Lower reported rental income (360000-45000)	3,15,000
Excess warranty expenses reported (26000 -14000)	12,000	3,27,000
Item influencing DTL
Excess depreciation as per tax law (180000-60000)	1,20,000
Excess gross profit reported in accounts (420000-220000)	2,00,000	3,20,000
Excess of DTA influencing items		7,000
Deferred Tax Assets (7000 *30%)		2,100
(iv) Journal Entry
	$	$
Income Tax Expenses	2,00,700
Current Tax Payable		2,00,700
Deferred Tax Assets	2,100
Income Tax Expenses		2,100