Question

Case 12-7 Accounting for Income Taxes: Different Approaches

Mark or Make is a bourbon distillery. Sales have been steady for the past three years, and operating costs have remained unchanged. On January 1, 2019, Mark or Make took advantage of a special deal to prepay its rent for three years at a substantial savings. The amount of the prepayment was $60,000. The income statement items (excluding the rent) are shown here.

	2019	2020	2021
Gross profit on sales	350,000	349,000	351,000
Operating expense	210,000	210,000	210,000

Assume that the rental is deducted on the corporate tax purposes in 2019 and that there are no other temporary differences between taxable income and pretax accounting income. In addition, there are no permanent differences between taxable income and pretax accounting income. The corporate tax rate for all three years is 30%.

Required:

1. Construct income statements for 2019, 2020, and 2021 under the following approaches to interperiod income tax allocation:

1. No allocation

2. Comprehensive allocation

2. Do you believe that no allocation distorts Mark or Make’s net income? Explain.

3. For years 2019 and 2020, Mark or Make reported net income applying the concept of comprehensive interperiod income tax allocation. During 2020, Congress passed a new tax law that will increase the corporate tax rate from 30 to 33%. Reconstruct the income statements for 2020 and 2019 under the following assumptions:

1. Mark or Make uses the deferred method to account for interperiod income tax allocation.

2. Mark or Make uses the asset–liability approach to account for interperiod income tax allocation.

4. Which of the two approaches used in question (a) provides measures of income and liabilities that are useful to decision makers? Explain.