Question

The long-term liabilities section of CPS Transportation’s December 31, 2017, balance sheet included the following: (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

a. A lease liability with 15 remaining lease payments of $26,000 each, due annually on January 1:

Lease liability	$	197,758
Less: current portion		6,224
	$	191,534

  
The incremental borrowing rate at the inception of the lease was 11% and the lessor’s implicit rate, which was known by CPS Transportation, was 10%.
  
b. A deferred income tax liability due to a single temporary difference. The only difference between CPS Transportation’s taxable income and pretax accounting income is depreciation on a machine acquired on January 1, 2017, for $480,000. The machine’s estimated useful life is five years, with no salvage value. Depreciation is computed using the straight-line method for financial reporting purposes and the MACRS method for tax purposes. Depreciation expense for tax and financial reporting purposes for 2018 through 2021 is as follows:

	MACRS			Straight-line
Year	Depreciation			Depreciation			Difference
2018	$	160,000		$	96,000		$	64,000
2019		80,000			96,000			(16,000	)
2020		70,000			96,000			(26,000	)
2021		60,000			96,000			(36,000	)

The enacted federal income tax rates are 35% for 2017 and 40% for 2018 through 2021. For the year ended December 31, 2018, CPS’s income before income taxes was $880,000.

On July 1, 2018, CPS Transportation issued $580,000 of 9% bonds. The bonds mature in 12 years and interest is payable each January 1 and July 1. The bonds were issued at a price to yield the investors 10%. CPS records interest at the effective interest rate.

Required:
1. Determine CPS Transportation’s income tax expense and net income for the year ended December 31, 2018.
2. Determine CPS Transportation’s interest expense for the year ended December 31, 2018.
3. Prepare the long-term liabilities section of CPS Transportation's December 31, 2018, balance sheet.

Answer 1

1)
CPS Transportation
INCOME TAX EXPENSE AND NET INCOME
For the Year Ended December 31, 2018
Income before income taxes		880000
Less: Income tax expense:
Current (40% x [$880,000 –64,000])	326400
Deferred (see calculation below)	25600	352000
Net income		528000
Deferred income tax expense
Reversal of temporary differences from depreciation giving rise to future taxable amounts
2019	-16000
2020	-26000
2021	-36000
Total	-78000
Effective tax rate for years 2019 through 2021	40%
Deferred tax liability, Dec. 31, 2018		-31200
Less: Dec. 31, 2017 deferred tax liability
Temporary difference-depreciation
2018	64000
2019	-16000
2020	-26000
2021	-36000
Total	-14000
Effective tax rate for years 2018 through 2021	40%
Deferred tax liability, Dec. 31, 2018		-5600
Increase (credit) needed		-25600
2)
CPS Transportation’s interest expense for the year ended December 31, 2018
Capital lease obligation : (191,534 x 10%)	$    19,153.40
Bonds payable = $539,983.94 x 10%/2	26999.19694
Total Interest Expense	46152.59694
Face Value	580000
Coupon payment = PMT = 580000x 9%/2	26100
Rate = 10%/2	0.05
Period = 12 x 2	24
Current Price = PV	$ 5,39,983.94
3)
CPS Transportation
LONG-TERM LIABILITIES SECTION OF BALANCE SHEET
43465
Long-term liabilities:
Lease liability - 12 payments of $26000 due annually on January 1	$ 1,91,534.00
Less: current portion ($26000 – 19,153.40)	$      6,846.60	$1,84,687.40
9% bonds payable due June 30, 2028,	$ 5,80,000.00
Less: unamortized discount $40016.06 + ((4.5% x $580,000) - 26999.196)	$    39,116.86	$5,40,883.14
Deferred income tax liability (Part 1)		$   31,200.00
Total long-term liabilities		$7,56,770.54
Face Value	$ 5,80,000.00
Issued Price	$ 5,39,983.94
Discount	$    40,016.06

Formula Bar 32 INCOME TAX EXPENSE AND NET INCOME 33 For the Year Ended December 31, 2018 34 Income before income taxes 35 Less: Income tax expense 36 Current (40% x [$880,000-64 ,0001) 37 Deferred (see calculation below) 38 Net income 39 40 Deferred income tax expense 41 Reversal of temporary differences from depreciation giving rise to future taxable amounts 42 2019 43 2020 44 2021 45 Total 46 Effective tax rate for years 2019 through 2021 47 Deferred tax liability, Dec. 31, 2018 48 Less: Dec. 31, 2017 deferred tax liability 49 Temporary difference-depreciation 50 2018 51 2019 52 2020 53 2021 54 Total 55 Effective tax rate for years 2018 through 2021 56 Deferred tax liability, Dec. 31, 2018 57 Increase (credit) needed 880000 0.4 (880000-64000) -C57 -B36+B37 -C34-C37 16000 26000 36000 SUM B42:B44) -B45 B46 64000 -B42 -B43 -B44 SUM B50:B53) -B54 B55 -C47-C56 59 CPS Transportation's interest expense for the year ended December 31,2018 60 Capital lease obligation : (191,534 x 10%) 61 Bonds payable $539,983.94 x 10%2 62 Total Interest Expense 63 64 Face Value 65 Coupon payment-PMT-580000x 9%)2 66 Rate= 10%/2 67 Period 12 x2 68 Current Price= PV 69 70 3) 71 CPS Transportation 72 LONG-TERM LIABILITIES SECTION OF BALANCE SHEET 73 43465 74 Long-term liabilities: -191534 0.1 B68"0.05 -B60+B61 580000 B64·0.09/2 24 PV(B66,B67-B65,-B64) 75 Lease liability -12 payments of $26000 due annually on January 1 76 Less: current portion ($26000-19,153.40) 191534 -26000-B60 -B75-B76 78 9% bonds payable due June 30, 2028 79 Less: unamortized discount $40016.06+(4.5% x $580,000)-26999.196) 80 Deferred income tax liability (Part 1) 81 Total long-term lia bilities 580000 -B85+B65-B61 -B78-B79 -C47