Question

P18.12 Carly Inc. reported the following accounting income (loss) and related tax rates during the years 2015 to 2021:

Year		Accounting Income (Loss)		Tax Rate
2015		$  70,000		25%
2016		25,000		25%
2017		60,000		25%
2018		80,000		30%
2019		(210,000)		35%
2020		70,000		30%
2021		90,000		25%

Accounting income (loss) and taxable income (loss) were the same for all years since Carly began business. The tax rates from 2018 to 2021 were enacted in 2018. Assume Carly Inc. follows ASPE for all parts of this question, except when asked about the effect of reporting under IFRS in part (b).

Instructions

a. Prepare the journal entries to record income taxes for the years 2019 to 2021. Assume that Carly uses the carryback provision where possible and expects to realize the benefits of any loss carryforward in the year that immediately follows the loss year.

b. Indicate the effect of the 2019 entry(ies) on the December 31, 2019 SFP if Carly follows the ASPE future/deferred income taxes method. Indicate as well the effect on the SFP if Carly reports under IFRS.

c. Show how the bottom portion of the income statement would be reported in 2019, beginning with “Loss before income tax.”

d. Show how the bottom portion of the income statement would be reported in 2020, starting with “Income before income tax.”

e. Prepare the journal entries for the years 2019 to 2021 to record income taxes, assuming that Carly uses the carryback provision where possible but is uncertain if it will realize the benefits of any loss carryforward in the future. Carly does not use a valuation allowance.

f. Assume now that Carly uses a valuation allowance account along with its Future Tax Asset account. Identify which entries in part (e) would differ and prepare them.

g. Based on your entries in part (e), indicate how the bottom portion of the income statements for 2019 and 2020 would be reported, beginning with “Income (loss) before income tax.”

h.  From a cash flow perspective, can you think of any advantage in using the valuation allowance for financial reporting purposes? Can you think of any advantage in not using it?

Answer 1

(a)                                                                   

                                                                    2019

Income Tax Receivable—2016..........................................          6,250

          ($25,000 X 25%)

Income Tax Receivable—2017..........................................        15,000

         ($60,000 X 25%)

Income Tax Receivable—2018..........................................        24,000

        ($80,000 X 30%)

          Current Tax Benefit.................................................                                45,250

Note: An acceptable alternative is to record only one Income Tax Receivable account for the amount of $45,250.

         

          Future Tax Asset................................................................        13,500

                    Future Tax Benefit ..................................................                                13,500

                      ($210,000 – $25,000 – $60,000 – $80,000 = $45,000)

                      ($45,000 X 30% = $13,500)

2020

          Current Tax Expense.........................................................          7,500

                    Income Tax Payable.................................................                                 7,500

                      [($70,000 – $45,000) X 30%]

         

          Future Tax Expense...........................................................        13,500

                    Future Tax Asset......................................................                                13,500

                    ($13,500– $0)

2021

          Current Tax Expense.........................................................        22,500

                    Income Tax Payable ($90,000 X 25%)....................                                22,500

(b)      An income tax receivable account totalling $45,250 will be reported under current assets  on the statement of financial position at December 31, 2019. This type of receivable is usually listed immediately above inventory in the current asset section. This receivable is normally collec­tible within two months of filing the amendment to the tax returns reflecting the carryback. Under ASPE, a future tax asset of $13,500 should also be classified as a current asset because the benefits of the loss carryforward are expected to be realized in the year that immediately follows the loss year, which means the benefits are expected to be realized in 2020. A current future tax asset is usually listed at or near the end of the list of current assets on the balance sheet. Also, retained earnings are increased by $58,750($45,250 + $13,500) as a result of the entries to record the benefits of the loss carryback and the loss carryforward.

          If Carly Inc. reports under IFRS, the deferred tax asset related to the loss carryforward would be classified as a non-current asset on the statement of financial position.

(c)                                                                   

2019 Income Statement

Operating loss before income tax                                                                          ($210,000)

Income tax benefit

        Current benefit due to loss carryback                                    $45,250                           

        Future benefit due to loss carryforward                                13,500                58,750

  Net loss ($151,250)

(d)                                                                  

2020 Income Statement

Income before income tax                                                                                        $70,000

Income tax expense

          Current                                                                                 $7,500 a                            

          Future                                                                                  13,500                 21,000

Net income $49,000               

  a [($70,000 – $45,000) X 30%]

(e)                                                                   

2019

Income Tax Receivable—2016....................................................          6,250

          ($25,000 X 25%)

Income Tax Receivable—2017....................................................        15,000

        ($60,000 X 25%)

Income Tax Receivable—2018....................................................        24,000

         ($80,000 X 30%)

Current Tax Benefit...........................................................                                45,250

Although its related possible income tax benefit is not recognized in the accounts, Carly Inc. has a tax loss carryforward of $45,000 which is required to be disclosed.

2020

          Current Tax Expense.........................................................          7,500

                    Income Tax Payable.................................................                                 7,500

                      [($70,000 – $45,000) X 30%]

2021

          Current Tax Expense.........................................................        22,500

                    Income Tax Payable ($90,000 X 25%)....................                                22,500

(f)       2019: entry for current taxes – no change

           2019: if a valuation allowance is used, the full income tax benefit and deferred tax asset related to the tax loss carryforward is recognized and then offset by the allowance, as follows.

Future Tax Asset...............................................................        13,500

Future Tax Benefit..................................................                                13,500

          ($45,000 X 30% = $13,500)

Future Tax Expense...........................................................        13,500

Allowance to Reduce Future Tax

      Asset to Expected Realizable Value..............        13,500

                        ($13,500– $0)

2020: entry for current taxes – no change

2020: because the tax loss carryforward has now been used, both the amount in the deferred tax account and in its allowance account must be removed, as follows.

Deferred Tax Expense ......................................................        13,500

Deferred Tax Asset..............................................                                13,500

           Allowance to Reduce Future Tax Asset

                              to Expected Realizable Value........................        13,500

Future Tax Benefit..................................................                                13,500

Alternatively, one entry could have been made:

Allowance to Reduce Future Tax Asset

                              to Expected Realizable Value........................        13,500

Future Tax Asset..................................................                                13,500

2020: No change to part (e) entry.

(g)

2019 Income Statement

        Operating loss before income tax                                                                  ($210,000)

        Income tax benefit

              Current benefit due to loss carryback                                                          45,250

        Net loss ($164,750)

2020 Income Statement

          Income before income tax                                                                              $70,000

          Income tax expense – Current a                                                                          7,500

          Net income   $62,500

  a[($70,000 – $45,000) X 30%]  

(h)      Using the valuation allowance instead of applying the reduction in value directly does not have any impact on cash flows. The use of the contra allowance simply permits the recording of the full benefits associated with all future deductible amounts in the asset account. This facilitates tracking for management purposes. It has no use for financial reporting purposes except, perhaps, for the transparency of the information. Readers can see the total possible benefits and the extent to which management has judged they will not be realized. Use of the allowance has no impact on cash flows.