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CHAPTER 19ACCOUNTING FOR INCOME TAXES CHAPTER LEARNING OBJECTIVES 1. Identify differences between pretax financial income and taxable income. 2. Describe a temporary difference that results in future taxable amounts. 3. Describe a temporary difference that results in future deductible amounts. 4. Explain the non-recognition of a deferred tax asset. 5. Describe the presentation of income tax expense in the income statement. 6. Describe various temporary and permanent differences. 7. Explain the effect of various tax rates and tax rate changes on deferred income taxes. 8. Apply accounting procedures for a loss carryback and a loss carry forward. 9. Describe the presentation of income taxes in financial statements. 10. Indicate the basic principles of the asset-liability method. 19 - 2 Test Bank for Intermediate Accounting, IFRS Edition, 2e TRUE-FALSE—Conceptual 1. Taxable income is a tax accounting term and is also referred to as income before taxes. 2. Pretax financial income is the amount used to compute income tax payable. 3. Taxable amounts increase taxable income in future years. 4. A deferred tax liability represents the increase in taxes payable in future years as a result of taxable temporary differences existing at the end of the current year. 5. Deductible amounts cause taxable income to be greater than pretax financial income in the future as a result of existing temporary differences. 6. A deferred tax asset represents the increase in taxes refundable in future years as a result of deductible temporary differences existing at the end of the current year. 7. A company reduces a deferred tax asset if it is possible that it will not realize some portion of the deferred tax asset. 8. Companies should consider both positive and negative evidence to determine whether, based on the weight of available evidence, it needs adjust the deferred tax asset. 9. A company should add a decrease in a deferred tax liability to income tax payable in computing income tax expense. 10. Taxable temporary differences will result in taxable amounts in future years when the related assets are recovered. 11. Examples of taxable temporary differences are subscriptions received in advance and advance rental receipts. 12. Permanent differences do not give rise to future taxable or deductible amounts. 13. Companies must consider presently enacted changes in the tax rate that become effective in future years when determining the tax rate to apply to existing temporary differences. 14. When a change in the tax rate is enacted, the effect is reported as an adjustment to income tax payable in the period of the change. 15. Under the loss carryback approach, companies must apply a current year loss to the most recent year first and then to an earlier year. 16. The tax effect of a loss carryforward represents future tax savings and results in the recognition of a deferred tax asset. 17. A possible source of taxable income that may be available to realize a tax benefit for loss carryforwards is existing taxable temporary differences. 18. An individual deferred tax asset or liability is classified as current or non-current based on the classification of the related asset/liability for financial reporting purposes. Accounting for Income Taxes 19 - 3 19. Companies classify the balances in the deferred tax accounts on the statement of financial position as non-current assets or non-current liabilities. 20. The IASB believes that the deferred tax method is the most consistent method for accounting for income taxes. True-False Answers—Conceptual Item 1. 2. 3. 4. 5. Ans. F F T T F Item 6. 7. 8. 9. 10. Ans. T F T F T Item 11. 12. 13. 14. 15. Ans. F T T F F Item 16. 17. 18. 19. 20. Ans. T T F T F MULTIPLE CHOICE—Conceptual 21. Taxable income of a corporation a. differs from accounting income due to differences in intraperiod allocation between the two methods of income determination. b. differs from accounting income due to differences in interperiod allocation and permanent differences between the two methods of income determination. c. is based on international financial reporting standards. d. is reported on the corporation's income statement. 22 Taxable income of a corporation differs from pretax financial income because of a. b. c. d. Permanent Differences No No Yes Yes Temporary Differences No Yes Yes No 23. The deferred tax expense is the a. increase in balance of deferred tax asset minus the increase in balance of deferred tax liability. b. increase in balance of deferred tax liability minus the increase in balance of deferred tax asset. c. increase in balance of deferred tax asset plus the increase in balance of deferred tax liability. d. decrease in balance of deferred tax asset minus the increase in balance of deferred tax liability. 24. Each of the following is determined according to IFRS except a. income before taxes. b. taxable income. c. income for financial reporting purposes. d. income for book purposes. 19 - 4 Test Bank for Intermediate Accounting, IFRS Edition, 2e 25. An assumption inherent in a company’s IFRS statement of financial position is that companies recover and settle the assets and liabilities at a. the amount that is probable where “probable” means a level of likelihood of at least more than 50%. b. the present value of future cash flows. c. their reported amounts. d. their net realizable value. 26. Machinery was acquired at the beginning of the year. Depreciation recorded during the life of the machinery could result in a. b. c. d. P S Future Taxable Amounts Yes Yes No No Future Deductible Amounts Yes No Yes No 27. A temporary difference arises when a revenue item is reported for tax purposes in a period After it is reported Before it is reported in financial income in financial income a. Yes Yes b. Yes No c. No Yes d. No No 28. Under IFRS a. “probable” is defined as a level of likelihood of at least slightly more than 60%. b. a company should reduce a deferred tax asset when it’s likely that some or all of it will not be recognized. c. a company considers only positive evidence when determining whether to recognize a deferred tax asset. d. deferred tax assets must be evaluated at the end of each accounting period. 29. Which of the following statements is correct regarding deferred taxes under IFRS? a. Income tax payable plus or minus the change in deferred income taxes equals income tax expense. b. The current portion of income tax expense is the amount of change in deferred taxes related to the current period. c. In computing income tax expense, a company deducts an increase in a deferred tax liability to income tax payable. d. All of the choices are correct. 30. At the December 31, 2015 statement of financial position date, Unruh Corporation reports an accrued receivable for financial reporting purposes but not for tax purposes. When this asset is recovered in 2016, a future taxable amount will occur and a. pretax financial income will exceed taxable income in 2016. b. Unruh will record a decrease in a deferred tax liability in 2016. c. total income tax expense for 2016 will exceed current tax expense for 2016. d. Unruh will record an increase in a deferred tax asset in 2016. Accounting for Income Taxes P 31. 19 - 5 Assuming a 40% statutory tax rate applies to all years involved, which of the following situations will give rise to reporting a deferred tax liability on the balance sheet? I. II. III. IV. a. b. c. d. A revenue is deferred for financial reporting purposes but not for tax purposes. A revenue is deferred for tax purposes but not for financial reporting purposes. An expense is deferred for financial reporting purposes but not for tax purposes. An expense is deferred for tax purposes but not for financial reporting purposes. item II only items I and II only items II and III only items I and IV only S 32. A major distinction between temporary and permanent differences is a. permanent differences are not representative of acceptable accounting practice. b. temporary differences occur frequently, whereas permanent differences occur only once. c. once an item is determined to be a temporary difference, it maintains that status; however, a permanent difference can change in status with the passage of time. d. temporary differences reverse themselves in subsequent accounting periods, whereas permanent differences do not reverse. S 33. Which of the following are temporary differences that are normally classified as expenses or losses that are deductible after they are recognized in financial income? a. Advance rental receipts. b. Product warranty liabilities. c. Depreciable property. d. Fines and expenses resulting from a violation of law. S 34. Which of the following is a temporary difference classified as a revenue or gain that is taxable after it is recognized in financial income? a. Subscriptions received in advance. b. Prepaid royalty received in advance. c. Sales accounted for on the accrual basis for financial reporting purposes and on the installment (cash) basis for tax purposes. d. Interest received on government obligations. S 35. Which of the following differences would result in future taxable amounts? a. Expenses or losses that are tax deductible after they are recognized in financial income. b. Revenues or gains that are taxable before they are recognized in financial income. c. Revenues or gains that are recognized in financial income but are never included in taxable income. d. Expenses or losses that are tax deductible before they are recognized in financial income. 19 - 6 Test Bank for Intermediate Accounting, IFRS Edition, 2e 36. Stuart Corporation's taxable income differed from its accounting income computed for this past year. An item that would create a permanent difference in accounting and taxable incomes for Stuart would be a. a balance in the Unearned Rent account at year end. b. using accelerated depreciation for tax purposes and straight-line depreciation for book purposes. c. a fine resulting from violations of environmental regulations. d. making installment sales during the year. 37. An example of a permanent difference is a. fines resulting from a violation of law. b. interest expense on money borrowed to invest in government bonds. c. percentage depletion of natural resources. d. All of these answer choices are correct. 38. Which of the following will not result in a temporary difference? a. Product warranty liabilities b. Advance rental receipts c. Gain on involuntary conversion of non-monetary asset. d. All of these answer choices will result in a temporary difference. 39. A company uses the equity method to account for an investment. This would result in what type of difference and in what type of deferred income tax? a. b. c. d. 40. Deferred Tax Asset Liability Asset Liability A company records an unrealized loss on short-term securities. This would result in what type of difference and in what type of deferred income tax? a. b. c. d. 41. Type of Difference Permanent Permanent Temporary Temporary Type of Difference Temporary Temporary Permanent Permanent Deferred Tax Liability Asset Liability Asset Which of the following temporary differences results in a deferred tax asset in the year the temporary difference originates? I. Accrual for product warranty liability. II. Subscriptions received in advance. III. Prepaid insurance expense. a. I and II only. b. II only. c. III only. d. I and III only. Accounting for Income Taxes S 19 - 7 42. Which of the following is not considered a permanent difference? a. Interest received on government obligations. b. Fines resulting from violating the law. c. Percentage depletion of natural resources. d. Stock-based compensation expense. 43. Which of the following statements is correct regarding permanent differences under IFRS? a. Permanent differences result from items that enter into pretax financial income but never into taxable income. b. Permanent differences result from items that enter into taxable income but never into pretax financial income. c. Permanent differences affect only the period in which they occur. d. All of these answer choices are correct. 44. Under IFRS when a change in the tax rates is enacted I. Companies should record its effect on existing deferred tax accounts immediately. II. Companies report the effect of changes in tax rates on deferred tax accounts in the period the new rate becomes effective. III. Companies report the effect of changes in tax rates on deferred tax accounts that arise in future periods when the new tax rates are in effect. a. I Only. b. II Only. c. III Only. d. Either I, II, or III, depending on how frequently tax rates change in the company’s tax jurisdiction. 45. When a change in the tax rate is enacted into law, its effect on existing deferred income tax accounts should be a. handled retroactively in accordance with the guidance related to changes in accounting standards. b. considered, but it should only be recorded in the accounts if it reduces a deferred tax liability or increases a deferred tax asset. c. reported as an adjustment to tax expense in the period of change. d. applied to all temporary or permanent differences that arise prior to the date of the enactment of the tax rate change, but not subsequent to the date of the change. 46. Tax rates other than the current tax rate may be used to calculate the deferred income tax amount on the statement of financial position if a. it is probable that a future tax rate change will occur. b. it appears likely that a future tax rate will be greater than the current tax rate. c. the future tax rates have been enacted or substantially enacted. d. it appears likely that a future tax rate will be less than the current tax rate. 47. Recognition of tax benefits in the loss year due to a loss carryforward requires a. the establishment of a deferred tax liability. b. the establishment of a deferred tax asset. c. the establishment of an income tax refund receivable. d. only a note to the financial statements. 19 - 8 Test Bank for Intermediate Accounting, IFRS Edition, 2e 48. In determining whether to adjust a deferred tax asset, a company should a. consider all positive and negative information in determining the need for an adjustment. b. consider only the positive information in determining the need for an adjustment. c. take an aggressive approach in its tax planning. d. pass a recognition threshold, after assuming that it will be audited by taxing authorities. 49. Under IFRS deferred tax assets are recognized for I. Deductible temporary differences. II. Deductible permanent differences. III. Operating loss carryforwards. IV. Operating loss carrybacks. a. I, II, and III. b. I and III only. c. I and IV only. d. II and III only. 50. Under IFRS companies are required to provide a reconciliation between actual tax expense and the applicable tax rate. The purpose(s) of this reconciliation include I. Making better prediction of future cash flow. II. Predicating future cash flows for operating loss carryforwards. III. Assessing the composition of the net deferred income tax liability. IV. Assessing quality of earnings. a. I, III, and IV only. b. I, II and IV only. c. I and IV only. d. I, II, III and IV. 51. Major reason(s) for disclosure of deferred income tax information is (are) a. better assessment of quality of earnings. b. better predictions of future cash flows. c. that it may be helpful in predicating future cash flows for operating loss carryforwards. d. All of these answer choices are correct. 52. Accounting for income taxes can result in the reporting of deferred taxes as any of the following except a. a current or non-current asset. b. a current or non-current liability. c. a contra-asset account. d. All of these answer choices are acceptable methods of reporting deferred taxes. 53. Deferred taxes should be presented on the statement of financial position a. as one net debit or credit amount. b. as a net amount in the non-current section. c. in two amounts: one for the net debit amount and one for the net credit amount. d. as reductions of the related asset or liability accounts. Accounting for Income Taxes S 19 - 9 54. Tanner, Inc. incurred a financial and taxable loss for 2016. Tanner therefore decided to use the carryback provisions as it had been profitable up to this year. How should the amounts related to the carryback be reported in the 2016 financial statements? a. The reduction of the loss should be reported as a prior period adjustment. b. The refund claimed should be reported as a deferred charge and amortized over five years. c. The refund claimed should be reported as revenue in the current year. d. The refund claimed should be shown as a reduction of the loss in 2016. 55. Companies allocate income tax expense (or benefit) to all of the following except a. discontinued operations. b. prior period adjustments. c. gross profit. d. other comprehensive income. 56. All of the following are procedures for the computation of deferred income taxes except to a. identify the types and amounts of existing temporary differences and carryforwards. b. measure the deferred tax liability for taxable temporary differences. c. measure the deferred tax asset for deductible temporary differences and loss carrybacks. d. All of these answer choices are procedures in computing deferred income taxes. 57. The IASB believes that the __________________ method is the most consistent method for accounting for income taxes. a. Asset-liability. b. Income statement. c. Statement of financial position. d. Revenue-expense. 58. The IASB believes that the asset-liability method is the most consistent method for accounting for income taxes. Basic principles of this method include I. A current tax liability or asset is recognized for the estimated taxes payable or refundable on the tax return for the current year. II. A deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and carryforwards. III. The measurement of current and deferred tax liabilities and assets, is based on provisions of the enacted tax law. IV. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized. a. I, II and only. b. II and III only. c. I, II, and IV only. d. I, II, III and IV. 19 - 10 Test Bank for Intermediate Accounting, IFRS Edition, 2e 59. Which of the following statements is incorrect with regards to IFRS and U.S. GAAP? a. With regard to uncertain tax positions, under IFRS, all potential liabilities must be recognized. b. The tax effects related to certain items are reported in equity under U.S. GAAP, under IFRS the tax effects are charged or credited to income. c. U.S. GAAP uses an impairment approach for deferred tax assets. The deferred tax asset is recognized in full and reduced by a valuation account if it is more likely than not all or a portion of the deferred tax asset will not be realized. d. U.S. GAAP classifies deferred taxes based on the classification of the assets or liability to which it relates. 60. Which of the following statements is correct with regards to IFRS and U.S. GAAP? a. Under U.S. GAAP, all potential liabilities related to uncertain tax positions must be recognized. b. The tax effects related to certain items are reported under U.S. GAAP; under IFRS the tax effects are charged or credited to income. c. IFRS uses an affirmative judgment approach for deferred tax assets, whereas U.S. GAAP uses an impairment approach for deferred tax assets. d. IFRS classifies deferred taxes based on classification of the asset or liability to which it relates. Multiple Choice Answers—Conceptual Item 21. 22. 23. 24. 25. 26. Ans. b c b b c b Item 27. 28. 29. 30. 31. 32. Ans. a d a b a d Item 33. 34. 35. 36. 37. 38. Ans. b c d c d d Item 39. 40. 41. 42. 43. 44. Ans. d b a d d a Item 45. 46. 47. 48. 49. 50. Ans. c c b a b b Item 51. 52. 53. 54. 55. 56. Ans. Item Ans. d c b d c c 57. 58. 59. 60. a d b c Accounting for Income Taxes 19 - 11 MULTIPLE CHOICE—Computational Use the following information for questions 61 and 62. At the beginning of 2016, Pitman Co. purchased an asset for $600,000 with an estimated useful life of 5 years and an estimated residual value of $50,000. For financial reporting purposes the asset is being depreciated using the straight-line method; for tax purposes the double-decliningbalance method is being used. Pitman Co.’s tax rate is 40% for 2016 and all future years. 61. At the end of 2016, what is the book basis and the tax basis of the asset? Book basis Tax basis a. $440,000 $310,000 b. $490,000 $310,000 c. $490,000 $360,000 d. $440,000 $360,000 62. At the end of 2016, which of the following deferred tax accounts and balances is reported on Pitman’s statement of financial position? Account _ Balance a. Deferred tax asset $52,000 b. Deferred tax liability $52,000 c. Deferred tax asset $78,000 d. Deferred tax liability $78,000 63. Lehman Corporation purchased a machine on January 2, 2013, for $2,000,000. The machine has an estimated 5-year life with no residual value. The straight-line method of depreciation is being used for financial statement purposes and the following accelerated depreciation amounts will be deducted for tax purposes: 2013 2014 2015 $400,000 640,000 384,000 2016 2017 2018 $230,000 230,000 116,000 Assuming an income tax rate of 30% for all years, the net deferred tax liability that should be reflected on Lehman's statement of financial position at December 31, 2014, should be a. b. c. d. Deferred Tax Liability Current Noncurrent $0 $72,000 $4,800 $67,200 $67,200 $4,800 $72,000 $0 Use the following information for questions 64 and 65. Mathis Co. at the end of 2014, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $ 500,000 Estimated litigation expense 1,250,000 Installment sales (1,000,000) Taxable income $ 750,000 19 - 12 Test Bank for Intermediate Accounting, IFRS Edition, 2e The estimated litigation expense of $1,250,000 will be deductible in 2016 when it is expected to be paid. The gross profit from the installment sales will be realized in the amount of $500,000 in each of the next two years. The estimated liability for litigation is classified as non-current and the installment accounts receivable are classified as $500,000 current and $500,000 noncurrent. The income tax rate is 30% for all years. 64. The income tax expense is a. $150,000. b. $225,000. c. $250,000. d. $500,000. 65. The net deferred tax asset to be recognized is a. $75,000. b. $150,000. c. $375,000. d. $225,000. Use the following information for questions 66 and 77. Hopkins Co. at the end of 2015, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income Estimated litigation expense Extra depreciation for taxes Taxable income $ 750,000 1,000,000 (1,500,000) $ 250,000 The estimated litigation expense of $1,000,000 will be deductible in 2016 when it is expected to be paid. Use of the depreciable assets will result in taxable amounts of $500,000 in each of the next three years. The income tax rate is 30% for all years. 66. Income taxes payable is a. $0. b. $75,000. c. $150,000. d. $225,000. 67. The net deferred tax liability to be recognized is a. $750,000. b. $450,000. c. $300,000. d. $150,000. Accounting for Income Taxes 68. 19 - 13 Eckert Corporation's partial income statement after its first year of operations is as follows: Income before income taxes Income tax expense Current Deferred Net income $3,750,000 $1,035,000 90,000 1,125,000 $2,625,000 Eckert uses the straight-line method of depreciation for financial reporting purposes and accelerated depreciation for tax purposes. The amount charged to depreciation expense on its books this year was $1,500,000. No other differences existed between book income and taxable income except for the amount of depreciation. Assuming a 30% tax rate, what amount was deducted for depreciation on the corporation's tax return for the current year? a. $1,200,000 b. $1,425,000 c. $1,500,000 d. $1,800,000 69. Cross Company reported the following results for the year ended December 31, 2015, its first year of operations: 2015 Income (per books before income taxes) $ 750,000 Taxable income 1,200,000 The disparity between book income and taxable income is attributable to a temporary difference which will reverse in 2016. What should Cross record as a net deferred tax asset or liability for the year ended December 31, 2015, assuming that the enacted tax rates in effect are 40% in 2015 and 35% in 2016? a. $180,000 deferred tax liability b. $157,500 deferred tax asset c. $180,000 deferred tax asset d. $157,500 deferred tax liability 70. In 2015, Krause Company accrued, for financial statement reporting, estimated losses on disposal of unused plant facilities of $1,500,000. The facilities were sold in March 2016 and a $1,500,000 loss was recognized for tax purposes. Also in 2015, Krause paid $100,000 in fines for violation of environmental regulations. Assuming that the enacted tax rate is 30% in both 2015 and 2016, and that Krause paid $780,000 in income taxes in 2015, the amount reported as net deferred income taxes on Krause's statement of financial position at December 31, 2015, should be a a. $420,000 asset. b. $360,000 asset. c. $360,000 liability. d. $450,000 asset. 71. Stephens Company has a deductible temporary difference of $2,000,000 at the end of its first year of operations. Its tax rate is 40 percent. Stephens has $1,800,000 of income taxes payable. After a careful review of all available evidence, Stephens determines that it is probable that it will not realize $200,000 of this deferred tax asset. On Stephens Company’s statement of financial position at the end of its first year of operations, what is the amount of deferred tax asset? a. $2,000,000 b. $1,800,000 c. $800,000 d. $720,000 19 - 14 Test Bank for Intermediate Accounting, IFRS Edition, 2e 72. Stephens Company has a deductible temporary difference of $2,000,000 at the end of its first year of operations. Its tax rate is 40 percent. Stephens has $1,800,000 of income taxes payable. At the end of the first year, after a careful review of all available evidence, Stephens determines that it is probable that it will not realize $200,000 of this deferred tax asset. At the end of the second year of operations, Stephens Company determines that it expects to realize $1,850,000 of this deferred tax assets. On Stephens Company’s statement of financial position at the end of its second year of operations, what is the amount of deferred tax asset? a. $800,000. b. $740,000. c. $60,000. d. $720,000 73. Link Sink Manufacturing has a deferred tax asset account with a balance of $300,000 at the end of 2015 due to a single cumulative temporary difference of $750,000. At the end of 2016, this same temporary difference has increased to a cumulative amount of $1,000,000. Taxable income for 2016 is $1,700,000. The tax rate is 40% for all years. Assuming it’s probable that 70% of the deferred tax asset will be realized, what amount will be reported on Link Sink’s statement of financial position for the deferred tax asset at December 31, 2016? a. $400,000. b. $280,000. c. $700,000. d. $680,000. 74. Stephens Company has a deductible temporary difference of $2,000,000 at the end of its first year of operations. Its tax rate is 40 percent. Stephens has $1,800,000 of income taxes payable. At the end of the first year, after a careful review of all available evidence, Stephens determines that it is probable that it will not realize $200,000 of this deferred tax asset. At the end of the second year of operations, Stephens Company determines that it expects to realize $1,850,000 of this deferred tax assets. On Stephens Company’s income statement for the second year, what amount of income tax expense will it report related to the temporary difference, and is the amount a debit or credit? a. $40,000 credit. b. $40,000 debit. c. $20,000 debit. d. $20,000 credit. 75. Link Sink Manufacturing has a deferred tax asset account with a balance of $300,000 at the end of 2015 due to a single cumulative temporary difference of $750,000. At the end of 2016, this same temporary difference has increased to a cumulative amount of $1,000,000. Taxable income for 2016 is $1,700,000. The tax rate is 40% for 2016, but enacted tax rates for all future years are 35%. Assuming it’s probable that 70% of the deferred tax asset will be realized, what amount will be reported on Link Sink’s statement of financial position for the deferred tax asset at December 31, 2016? a. $262,500. b. $280,000. c. $245,000. d. $595,000. Accounting for Income Taxes 76. 19 - 15 Watson Corporation prepared the following reconciliation for its first year of operations: Pretax financial income for 2015 $1,200,000 Tax exempt interest (100,000) Originating temporary difference (300,000) Taxable income $800,000 The temporary difference will reverse evenly over the next two years at an enacted tax rate of 40%. The enacted tax rate for 2015 is 28%. What amount should be reported in its 2015 income statement as the current portion of its provision for income taxes? a. $224,000 b. $320,000 c. $336,000 d. $480,000 Use the following information for questions 77 and 78. Mitchell Corporation prepared the following reconciliation for its first year of operations: Pretax financial income for 2015 Tax exempt interest Originating temporary difference Taxable income $ 900,000 (75,000) (225,000) $600,000 The temporary difference will reverse evenly over the next two years at an enacted tax rate of 40%. The enacted tax rate for 2015 is 35%. 77. What amount should be reported in its 2015 income statement as the deferred portion of income tax expense? a. $90,000 debit b. $120,000 debit c. $90,000 credit d. $105,000 credit 78. In Mitchell’s 2015 income statement, what amount should be reported for total income tax expense? a. $330,000 b. $315,000 c. $300,000 d. $210,000 79. Ferguson Company has the following cumulative taxable temporary differences: 12/31/16 $1,350,000 12/31/15 $960,000 The tax rate enacted for 2016 is 40%, while the tax rate enacted for future years is 30%. Taxable income for 2016 is $2,400,000 and there are no permanent differences. Ferguson's pretax financial income for 2016 is a. $3,750,000. b. $2,790,000. c. $2,010,000. d. $1,050,000. 19 - 16 Test Bank for Intermediate Accounting, IFRS Edition, 2e Use the following information for questions 80 through 82. Lyons Company deducts insurance expense of $84,000 for tax purposes in 2015, but the expense is not yet recognized for accounting purposes. In 2016, 2017, and 2018, no insurance expense will be deducted for tax purposes, but $28,000 of insurance expense will be reported for accounting purposes in each of these years. Lyons Company has a tax rate of 40% and income taxes payable of $72,000 at the end of 2015. There were no deferred taxes at the beginning of 2015. 80. What is the amount of the deferred tax liability at the end of 2015? a. $33,600 b. $28,800 c. $12,000 d. $0 81. What is the amount of income tax expense for 2015? a. $105,600 b. $100,800 c. $84,000 d. $72,000 82. Assuming that income taxes payable for 2016 is $96,000, the income tax expense for 2016 would be what amount? a. $129,600 b. $107,200 c. $96,000 d. $84,800 Use the following information for questions 83 and 84. Kraft Company made the following journal entry in late 2015 for rent on property it leases to Danford Corporation. Cash 60,000 Unearned Rent Revenue 60,000 The payment represents rent for the years 2016 and 2017, the period covered by the lease. Kraft Company is a cash basis taxpayer. Kraft has income tax payable of $92,000 at the end of 2015, and its tax rate is 35%. 83. What amount of income tax expense should Kraft Company report at the end of 2015? a. $53,000 b. $71,000 c. $81,500 d. $113,000 84. Assuming the income taxes payable at the end of 2016 is $102,000, what amount of income tax expense would Kraft Company record for 2016? a. $81,000 b. $91,500 c. $112,500 d. $123,000 Accounting for Income Taxes 85. 19 - 17 The following information is available for Kessler Company after its first year of operations: Income before taxes Federal income tax payable Deferred income tax Income tax expense Net income $250,000 $104,000 (4,000) 100,000 $150,000 Kessler estimates its annual warranty expense as a percentage of sales. The amount charged to warranty expense on its books was $95,000. Assuming a 40% income tax rate, what amount was actually paid this year for warranty claims? a. $105,000 b. $100,000 c. $95,000 d. $85,000 Use the following information for questions 86–88. At the beginning of 2015; Elephant, Inc. had a deferred tax asset of $4,000 and a deferred tax liability of $6,000. Pre-tax accounting income for 2015 was $300,000 and the enacted tax rate is 40%. The following items are included in Elephant’s pre-tax income: Interest income from government obligations Accrued warranty costs, estimated to be paid in 2016 Operating loss carryforward Installment sales revenue, will be collected in 2016 Prepaid rent expense, will be used in 2016 $24,000 $52,000 $38,000 $26,000 $12,000 86. What is Elephant, Inc.’s taxable income for 2015? a. $300,000 b. $252,000 c. $348,000 d. $452,000 87. Which of the following is required to adjust Elephant, Inc.’s deferred tax asset to its correct balance at December 31, 2015? a. A debit of $20,800 b. A credit of $15,200 c. A debit of $15,200 d. A debit of $16,800 88. The ending balance in Elephant, Inc’s deferred tax liability at December 31, 2015 is a. $9,200 b. $15,200 c. $10,400 d. $31,200 19 - 18 Test Bank for Intermediate Accounting, IFRS Edition, 2e Use the following information for questions 89 and 90. Rowen, Inc. had pre-tax accounting income of $900,000 and a tax rate of 40% in 2010, its first year of operations. During 2015 the company had the following transactions: Received rent from Jane, Co. for 2016 Government bonds interest income Depreciation for tax purposes in excess of book depreciation Installment sales revenue to be collected in 2016 $32,000 $40,000 $20,000 $54,000 89. For 2015, what is the amount of income taxes payable for Rowen, Inc? a. $301,600 b. $327,200 c. $343,200 d. $386,400 90. At the end of 2015, which of the following deferred tax accounts and balances is reported on Rowen, Inc.’s statement of financial position? Account _ Balance a. Deferred tax asset $12,800 b. Deferred tax liability $12,800 c. Deferred tax asset $20,800 d. Deferred tax liability $20,800 91. Based on the following information, compute 2015 taxable income for South Co. assuming that its pre-tax accounting income for the year ended December 31, 2015 is $230,000. Future taxable Temporary difference (deductible) amount Installment sales $192,000 Depreciation $60,000 Unearned rent ($200,000) a. b. c. d. 92. $282,000 $178,000 $482,000 $222,000 Fleming Company has the following cumulative taxable temporary differences: 12/31/16 12/31/15 $640,000 $900,000 The tax rate enacted for 2016 is 40%, while the tax rate enacted for future years is 30%. Taxable income for 2016 is $1,600,000 and there are no permanent differences. Fleming’s pretax financial income for 2016 is: a. b. c. d. $960,000 $1,340,000 $1,730,000 $2,240,000 Accounting for Income Taxes 19 - 19 93. Larsen Corporation reported $100,000 in revenues in its 2015 financial statements, of which $44,000 will not be included in the tax return until 2016. The enacted tax rate is 40% for 2015 and 35% for 2016. What amount should Larsen report for deferred tax liability in its statement of financial position at December 31, 2015? a. $15,400 b. $17,600 c. $19,600 d. $22,400 94. Duncan Inc. uses the accrual method of accounting for financial reporting purposes and appropriately uses the installment (cash) basis of accounting for income tax purposes. Profits of $300,000 recognized for books in 2014 will be collected in the following years: Collection of Profits 2015 $ 50,000 2016 $100,000 2017 $150,000 The enacted tax rates are: 40% for 2014, 35% for 2015, and 30% for 2016 and 2017. Taxable income is expected in all future years. What amount should be included in the December 31, 2014, statement of financial position for the deferred tax liability related to the above temporary difference? a. $17,500 b. $75,000 c. $92,500 d. $120,000 95. At December 31, 2014 Raymond Corporation reported a deferred tax liability of $90,000 which was attributable to a taxable temporary difference of $300,000. The temporary difference is scheduled to reverse in 2018. During 2015, a new tax law increased the corporate tax rate from 30% to 40%. Raymond should record this change by debiting a. Retained Earnings for $30,000. b. Retained Earnings for $9,000. c. Income Tax Expense for $9,000. d. Income Tax Expense for $30,000. 96. Palmer Co. had a deferred tax liability balance due to a temporary difference at the beginning of 2014 related to $600,000 of excess depreciation. In December of 2014, a new income tax act is signed into law that lowers the corporate rate from 40% to 35%, effective January 1, 2016. If taxable amounts related to the temporary difference are scheduled to be reversed by $300,000 for both 2015 and 2016, Palmer should increase or decrease deferred tax liability by what amount? a. Decrease by $30,000 b. Decrease by $15,000 c. Increase by $15,000 d. Increase by $30,000 19 - 20 Test Bank for Intermediate Accounting, IFRS Edition, 2e 97. A reconciliation of Gentry Company's pretax accounting income with its taxable income for 2015, its first year of operations, is as follows: Pretax accounting income Excess tax depreciation Taxable income $3,000,000 (90,000) $2,910,000 The excess tax depreciation will result in equal net taxable amounts in each of the next three years. Enacted tax rates are 40% in 2015, 35% in 2016 and 2017, and 30% in 2018. The total deferred tax liability to be reported on Gentry's statement of financial position at December 31, 2015, is a. $36,000. b. $30,000. c. $31,500. d. $27,000. 98. Khan, Inc. reports a taxable and financial loss of $650,000 for 2016. Its pretax financial income for the last two years was as follows: 2014 2015 $300,000 400,000 The amount that Khan, Inc. reports as a net loss for financial reporting purposes in 2016, assuming that it uses the carryback provisions, and that the tax rate is 30% for all periods affected, is a. $650,000 loss. b. $ -0-. c. $195,000 loss. d. $455,000 loss. Use the following information for questions 99 and 100. Wilcox Corporation reported the following results for its first three years of operation: 2014 income (before income taxes) 2015 loss (before income taxes) 2016 income (before income taxes) $ 100,000 (900,000) 1,000,000 There were no permanent or temporary differences during these three years. Assume a corporate tax rate of 30% for 2014 and 2015, and 40% for 2016. 99. Assuming that Wilcox elects to use the carryback provision, what net income (loss) is reported in 2015? (Assume that any deferred tax asset recognized is probable to be realized.) a. $(900,000) b. $ -0c. $(870,000) d. $(550,000) 100. Assuming that Wilcox elects to use the carryforward provision and not the carryback provision, what net income (loss) is reported in 2015? a. $(900,000) b. $(540,000) c. $ -0d. $(870,000) Accounting for Income Taxes 101. 19 - 21 Rodd Co. reports a taxable and pretax financial loss of $400,000 for 2016. Rodd's taxable and pretax financial income and tax rates for the last two years were: 2014 2015 $400,000 400,000 30% 35% The amount that Rodd should report as an income tax refund receivable in 2016, assuming that it uses the carryback provisions and that the tax rate is 40% in 2016, is a. $120,000. b. $140,000. c. $160,000. d. $180,000. 102. Nickerson Corporation began operations in 2014. There have been no permanent or temporary differences to account for since the inception of the business. The following data are available: Year Enacted Tax Rate Taxable Income Taxes Paid 2014 45% $750,000 $337,500 2015 40% 900,000 360,000 2016 35% 2017 30% In 2016, Nickerson had an operating loss of $930,000. What amount of income tax benefits should be reported on the 2016 income statement due to this loss? a. $409,500 b. $373,500 c. $372,000 d. $279,000 Use the following information for questions 103 and 104. Operating income and tax rates for C.J. Company’s first three years of operations were as follows: Income _ Enacted tax rate 2015 $100,000 35% 2016 ($250,000) 30% 2017 $420,000 40% 103. Assuming that C.J. Company opts to carryback its 2016 NOL, what is the amount of income taxes payable at December 31, 2017? a. $68,000 b. $168,000 c. $123,000 d. $108,000 104. Assuming that C.J. Company opts only to carryforward its 2016 NOL, what is the amount of deferred tax asset or liability that C.J. Company would report on its December 31, 2016 balance sheet? Amount _ Deferred tax asset or liability a. $75,000 Deferred tax liability b. $87,500 Deferred tax liability c. $100,000 Deferred tax asset d. $75,000 Deferred tax asset 19 - 22 Test Bank for Intermediate Accounting, IFRS Edition, 2e 105. Georgia, Inc. has no temporary or permanent differences. The company experiences the following: Year 2014 2015 2016 2017 Taxable income/loss $ 100,000 200,000 400,000 (500,000) Tax rate 35% 30% 40% ---- Tax paid $ 35,000 60,000 160,000 -0- In 2017, Georgia, Inc. decides to carry back its NOL. What amount of income tax refund receivable will Georgia record for 2017? a. $200,000 b. $180,000 c. $190,000 d. $ -0106. Lincoln Company has the following four deferred tax items at December 31, 2016. The deferred tax assets and the deferred tax liabilities relate to income taxes levied by the same tax authority. On Lincoln’s December 31, 2016 statement of financial position, it will report Temporary Difference Rent collected in advance: recognized when earned for accounting purposes and when received for tax purposes Deferred Tax Asset $84,000 Use of straight-line depreciation for accounting purposes and accelerated depreciation for tax purposes $428,000 Recognition of profits on installment sales during period of sale for accounting purposes and during period of collection for tax purposes Warranty liabilities: recognized for accounting purposes at time of sale; for tax purposes at time paid a. b. c. d. $108,000 current deferred tax asset. $626,000 non-current deferred tax liability. $410,000 non-current deferred tax liability. $518,000 current tax payable. Deferred Tax Liability 90,000 24,000 Accounting for Income Taxes 107. 19 - 23 Lincoln Company has the following four deferred tax items at December 31, 2016. The deferred tax assets and the deferred tax liabilities relate to income taxes levied by the same tax authority. On Lincoln’s December 31, 2016 statement of financial position, it will report Temporary Difference Deferred Tax Asset Rent collected in advance: recognized when earned for accounting purposes and when received for tax purposes Deferred Tax Liability $652,000 Use of straight-line depreciation for accounting purposes and accelerated depreciation for tax purposes $330,000 Recognition of profits on installment sales during period of sale for accounting purposes and during period of collection for tax purposes 64,000 Warranty liabilities: recognized for accounting purposes at time of sale; for tax purposes at time paid a. b. c. c. 37,000 $394,000 current deferred tax liability. $689,000 current deferred tax asset. $295,000 non-current deferred tax asset. $394,000 current tax receivable. Multiple Choice Answers—Computational Item 61. 62. 63. 64. 65. 66. 67. Ans. c b a a a b d Item 68. 69. 70. 71. 72. 73. 74. Ans. d b d d b b c Item 75. 76. 77. 78. 79. 80. 81. Ans. c a c c b a a Item 82. 83. 84. 85. 86. 87. 88. Ans. d b c d b d b Item 89. 90. 91. 92. 93. 94. 95. Ans. Item Ans. Item Ans. b a b b a c d 96. 97. 98. 99. 100. 101. 102. b b d d b a a 103. 104. 105. 106. 107. d c b c c 19 - 24 Test Bank for Intermediate Accounting, IFRS Edition, 2e MULTIPLE CHOICE—CPA Adapted 108. Munoz Corp.'s books showed pretax financial income of $1,500,000 for the year ended December 31, 2016. In the computation of income taxes, the following data were considered: Gain on an involuntary conversion $650,000 (Munoz has elected to replace the property within the statutory period using total proceeds.) Depreciation deducted for tax purposes in excess of depreciation deducted for book purposes 100,000 Estimated tax payments, 2016 125,000 Enacted tax rate, 2016 30% What amount should Munoz report as its current income tax liability on its December 31, 2016 statement of financial position? a. $100,000 b. $130,000 c. $225,000 d. $255,000 109. Haag Corp.'s 2016 income statement showed pretax accounting income of $750,000. To compute the income tax liability, the following 2016 data are provided: Income from government bonds $ 30,000 Depreciation deducted for tax purposes in excess of depreciation deducted for financial statement purposes 60,000 Estimated income tax payments made 150,000 Enacted corporate income tax rate 30% What amount of current income tax liability should be included in Hagg's December 31, 2016 statement of financial position? a. $48,000 b. $66,000 c. $75,000 d. $198,000 110. On January 1, 2016, Gore, Inc. purchased a machine for $720,000 which will be depreciated $72,000 per year for financial statement reporting purposes. For income tax reporting, Gore elected to expense $80,000 and to use straight-line depreciation which will allow a depreciation deduction of $64,000 for 2016. Assume a present and future enacted income tax rate of 30%. What amount should be added to Gore's deferred tax liability for this temporary difference at December 31, 2016? a. $43,200 b. $24,000 c. $21,600 d. $19,200 Accounting for Income Taxes 19 - 25 111. On January 1, 2016, Piper Corp. purchased 40% of the voting common stock of Betz, Inc. and appropriately accounts for its investment by the equity method. During 2016, Betz reported earnings of $360,000 and paid dividends of $120,000. Piper assumes that all of Betz's undistributed earnings will be distributed as dividends in future periods when the enacted tax rate will be 30%. Ignore the dividend-received deduction. Piper's current enacted income tax rate is 25%. The increase in Piper's deferred income tax liability for this temporary difference is a. $72,000. b. $60,000. c. $43,200. d. $28,800. 112. Foltz Corp.'s 2014 income statement had pretax financial income of $250,000 in its first year of operations. Foltz uses an accelerated depreciation method on its tax return and straight-line depreciation for financial reporting. The differences between the book and tax deductions for depreciation over the five-year life of the assets acquired in 2014, and the enacted tax rates for 2014 to 2018 are as follows: 2014 2015 2016 2017 2018 Book Over (Under) Tax $(50,000) (65,000) (15,000) 60,000 70,000 Tax Rates 35% 30% 30% 30% 30% There are no other temporary differences. In Foltz's December 31, 2014 statement of financial position, the non-current deferred tax liability and the income taxes currently payable should be a. b. c. d. 113. Non-current Deferred Tax Liability $39,000 $39,000 $15,000 $15,000 Income Taxes Currently Payable $50,000 $70,000 $60,000 $70,000 Didde Corp. prepared the following reconciliation of income per books with income per tax return for the year ended December 31, 2015: Book income before income taxes Add temporary difference Construction contract revenue which will reverse in 2016 Deduct temporary difference Depreciation expense which will reverse in equal amounts in each of the next four years Taxable income $1,200,000 160,000 (640,000) $720,000 Didde's effective income tax rate is 34% for 2015. What amount should Didde report in its 2015 income statement as the current provision for income taxes? a. $54,400 b. $244,800 c. $408,000 d. $462,400 19 - 26 Test Bank for Intermediate Accounting, IFRS Edition, 2e 114. In its 2015 income statement, Cohen Corp. reported depreciation of $1,110,000 and interest revenue on government obligations of $210,000. Cohen reported depreciation of $1,650,000 on its 2015 income tax return. The difference in depreciation is the only temporary difference, and it will reverse equally over the next three years. Cohen's enacted income tax rates are 35% for 2015, 30% for 2016, and 25% for 2017 and 2018. What amount should be included in the deferred income tax liability in Hertz's December 31, 2015 statement of financial position? a. $144,000 b. $186,000 c. $225,000 d. $262,500 115. Dunn, Inc. uses the accrual method of accounting for financial reporting purposes and appropriately uses the installment (cash) method of accounting for income tax purposes. Installment income of $900,000 will be collected in the following years when the enacted tax rates are: Collection of Income Enacted Tax Rates 2015 $ 90,000 35% 2016 180,000 30% 2017 270,000 30% 2018 360,000 25% The installment income is Dunn's only temporary difference. What amount should be included in the deferred income tax liability in Dunn's December 31, 2015 statement of financial position? a. $225,000 b. $256,500 c. $283,500 d. $315,000 116. For calendar year 2015, Kane Corp. reported depreciation of $1,200,000 in its income statement. On its 2015 income tax return, Kane reported depreciation of $1,800,000. Kane's income statement also included $225,000 accrued warranty expense that will be deducted for tax purposes when paid. Kane's enacted tax rates are 30% for 2015 and 2016, and 24% for 2017 and 2018. The depreciation difference and warranty expense will reverse over the next three years as follows: Depreciation Difference Warranty Expense 2016 $240,000 $ 45,000 2017 210,000 75,000 2018 150,000 105,000 $600,000 $225,000 These were Kane's only temporary differences. In Kane's 2015 income statement, the deferred portion of its provision for income taxes should be a. $200,700. b. $112,500. c. $101,700. d. $109,800. Accounting for Income Taxes 117. 19 - 27 Wright Co., organized on January 2, 2014, had pretax accounting income of $880,000 and taxable income of $1,600,000 for the year ended December 31, 2010 The only temporary difference is accrued product warranty costs which are expected to be paid as follows: 2015 2016 2017 2018 $240,000 120,000 120,000 240,000 The enacted income tax rates are 35% for 2014, 30% for 2015 through 2017, and 25% for 2018. If Wright expects taxable income in future years, the deferred tax asset in Wright's December 31, 2014 statement of financial position should be a. $144,000. b. $168,000. c. $204,000. d. $252,000. Multiple Choice Answers—CPA Adapted Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. 108. 109. a a 110. 111. c d 112. 113. d b 114. 115. a a 116. 117. c c DERIVATIONS — Computational No. Answer Derivation 61. c $600,000 – [($600,000 – $50,000)  5)] = $490,000; $600,000 – (600,000  1/5  2) = $360,000. 62. b ($490,000 – $360,000)  .40 = $52,000. 63. a ($640,000 – $400,000) × 30% = $72,000. 64. a Income taxes payable = ($750,000 × 30%) = $225,000 Change in deferred tax liability = ($1,000,000 × 30%) = $300,000 Change in deferred tax asset = ($1,250,000 × 30%) = $375,000 $225,000 + $300,000 – $375,000 = $150,000. 65. a ($1,250,000 – $1,000,000) × 30% = $75,000. 66. b ($250,000 × 30%) = $75,000. 67. d ($1,000,000 – $1,500,000) × 30% = $150,000. 68. d (30% × Temporary Difference) = $90,000; Temporary Difference = ($90,000 ÷ 30%) = $300,000; $1,500,000 + $300,000 = $1,800,000. 69. b ($1,200,000 – $750,000) × 35% = $157,500. 19 - 28 Test Bank for Intermediate Accounting, IFRS Edition, 2e DERIVATIONS — Computational (cont.) No. Answer Derivation 70. d ($1,500,000 × 30%) = $450,000. 71. d ($2,000,000 – $200,000) × .40 = $720,000. 72. b $1,850,000 × .40 = $740,000. 73. b ($1,000,000 × .70) × .40 = $280,000. 74. c ($1,850,000 × .40) – ($1,800,000 × .40) = $20,000 dr. 75. c ($1,000,000 × .70) × .35 = $245,000. 76. a $800,000  .28 = $224,000. 77. c $225,000 × .40 = $90,000 credit. 78. c ($600,000 × .35) + ($225,000 × .40) = $300,000. 79. b $2,400,000 + ($1,350,000 – $960,000) = $2,790,000. 80. a $84,000 × .40 = $33,600. 81. a $72,000 + ($84,000 × .40) = $105,600. 82. d $96,000 – ($28,000 × .40) = $84,800. 83. b $92,000 – ($60,000 × .35) = $71,000. 84. c $102,000 + ($30,000 × .35) = $112,500. 85. d $95,000 – ($4,000 ÷ .40) = $85,000. 86. b $300,000 – $24,000 + $52,000 – $38,000 – $26,000 – $12,000 = $252,000. 87. d ($52,000  .40) – $4,000 = $16,800. 88. b ($26,000 + $12,000)  .40 = $15,200. 89. b $900,000 + $32,000 – $40,000 – $20,000 – $54,000 = $818,000 $818,000  .40 = $327,200. 90. a $32,000  .40 = $12,800 DTA. 91. b $230,000 - $192,000 – $60,000 + $200,000 = $178,000. 92. b $1,600,000 – ($900,000 – $640,000) = $1,340,000. Accounting for Income Taxes 19 - 29 19 - 30 Test Bank for Intermediate Accounting, IFRS Edition, 2e DERIVATIONS — Computational (cont.) No. Answer Derivation 93. a $44,000  .35 = $15,400. 94. c ($50,000  .35) + [($100,000 + $150,000)  .30] = $92,500. 95. d $300,000  (.40 – .30) = $30,000 Income Tax Expense. 96. b $300,000 × (.35 – .40) = $15,000 decrease. 97. b ($30,000 × 35%) + ($30,000 × 35%) + ($30,000 × 30%) = $30,000. 98. d $650,000 – (30% × $650,000) = $455,000 loss. 99. d ($100,000 × 30%) = $30,000; $800,000 × 40% = $320,000; ($900,000 – $30,000 – $320,000) = $550,000. 100. b ($900,000 × 40%) = $360,000; $900,000 – $360,000 = $540,000. 101. a ($400,000 × 30%) = $120,000. 102. a ($750,000 × .45) + [($930,000 – $750,000) × .40] = $409,500. 103. d [$420,000 – ($250,000 – $100,000)]  .40 = $108,000. 104. c $250,000  .40 = $100,000. 105. b $60,000 + [($500,000 – $200,000)  .40] = $180,000. 106. c ($428,000 + $90,000) – ($84,000 + $24,000) = $410,000. 107. c ($652,000 + $37,000) – ($330,000 + $64,000) = $295,000. DERIVATIONS — CPA Adapted No. Answer Derivation 108. a ($1,500,000 – $650,000 – $100,000) × 30% = $225,000; $225,000 – $125,000 = $100,000. 109. a ($750,000 – $30,000 – $60,000) × 30% = $198,000; $198,000 – $150,000 = $48,000. 110. c ($80,000 + $64,000 – $72,000) × 30% = $21,600. 111. d ($360,000 – $120,000) × 40% = $96,000; $96,000 × 30% = $28,800. Accounting for Income Taxes 112. d 19 - 31 ($50,000 × 30%) = $15,000; ($250,000 – $50,000) × 35% = $70,000. DERIVATIONS — CPA Adapted (cont.) No. Answer Derivation 113. b ($720,000 × 34%) = $244,800. 114. a ($1,650,000 – $1,110,000)  3 = $180,000; ($180,000 × 30%) + ($180,000 × 25%) + ($180,000 × 25%) = $144,000. 115. a ($180,000 × 30%) + ($270,000 × 30%) + ($360,000 × 25%) = $225,000. 116. c ($240,000 – $45,000) × 30% = $58,500; ($210,000 – $75,000) × 24% = $32,400; ($150,000 – $105,000) × 24% = $10,800; $58,500 + $32,400 + $10,800 = $101,700. 117. c ($240,000 + $120,000 + $120,000) × 30% = $144,000; $240,000 × 25% = $60,000; $144,000 + $60,000 = $204,000. EXERCISES Ex. 19-118—Computation of taxable income. The records for Bosch Co. show this data for 2015:  Gross profit on installment sales recorded on the books was $360,000. Gross profit for tax purposes from collections of installment receivables was $270,000.  Machinery was acquired in January for $300,000. Straight-line depreciation over a ten-year life (no residual value) is used. For tax purposes, Accelerated depreciation is used and Bosch may deduct 20% for 2015.  Interest received on governmental obligations was $9,000.  The estimated warranty liability related to 2015 sales was $19,600. Repair costs under warranties during 2015 were $13,600. The remainder will be incurred in 2016.  Pretax financial income is $600,000. The tax rate is 30%. Instructions (a) Prepare a schedule starting with pretax financial income and compute taxable income. (b) Prepare the journal entry to record income taxes for 2015. Solution 19-118 (a) Pretax financial income Permanent differences Tax-exempt interest Temporary differences Installment sales ($360,000 – $270,000) Extra depreciation ($60,000 – $30,000) $600,000 (9,000) (90,000) (30,000) 19 - 32 Test Bank for Intermediate Accounting, IFRS Edition, 2e Warranties ($19,600 – $13,600) Taxable income (b) 6,000 $477,000 Income Tax Expense [$143,100 + ($36,000 – $1,800)] ............... Deferred Tax Asset (30% × $6,000) ............................................. Deferred Tax Liability (30% × $120,000) .......................... Income Taxes Payable (30% × $477,000) ........................ 177,300 1,800 36,000 143,100 Ex. 19-119—Future taxable and deductible amounts. Define temporary differences, future taxable amounts, and future deductible amounts. Solution 19-119 Temporary differences are differences between the tax basis of an asset or liability and its reported amount in the financial statements that will result in taxable amounts or deductible amounts in future years. Future taxable amounts increase taxable income in future years and cause a deferred tax liability to be recorded. Future deductible amounts decrease taxable income in future years and cause a deferred tax asset to be recorded. Ex. 19-120—Deferred income taxes. Pole Co. at the end of 2015, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income Extra depreciation taken for tax purposes Estimated expenses deductible for taxes when paid Taxable income $ 420,000 (1,050,000) 840,000 $ 210,000 Use of the depreciable assets will result in taxable amounts of $350,000 in each of the next three years. The estimated litigation expenses of $840,000 will be deductible in 2018 when settlement is expected. Instructions (a) Prepare a schedule of future taxable and deductible amounts. (b) Prepare the journal entry to record income tax expense, deferred taxes, and income taxes payable for 2015, assuming a tax rate of 40% for all years. Solution 19-120 (a) Future taxable (deductible) amounts Extra depreciation Litigation 2016 2017 $350,000 $350,000 2018 Total $350,000 $1,050,000 (840,000) (840,000) Accounting for Income Taxes 19 - 33 19 - 34 Test Bank for Intermediate Accounting, IFRS Edition, 2e (b) Income Tax Expense ($84,000 + $420,000 – $336,000) ............. Deferred Tax Asset ($840,000 × 40%) ......................................... Deferred Tax Liability ($1,050,000 × 40%) ....................... Income Taxes Payable ($210,000 × 40%) ........................ 168,000 336,000 420,000 84,000 Ex. 19-121—Deferred income taxes. Hunt Co. at the end of 2015, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows: Pretax financial income $ 750,000 Estimated expenses deductible for taxes when paid 1,200,000 Extra depreciation (1,350,000) Taxable income $ 600,000 Estimated warranty expense of $800,000 will be deductible in 2016, $300,000 in 2017, and $100,000 in 2018. The use of the depreciable assets will result in taxable amounts of $450,000 in each of the next three years. Instructions (a) Prepare a table of future taxable and deductible amounts. (b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2015, assuming an income tax rate of 40% for all years. Solution 19-121 (a) (b) 2016 Future taxable (deductible) amounts Warranties $(800,000) Excess depreciation 450,000 2017 2018 Total $(300,000) $(100,000) $(1,200,000) 450,000 450,000 1,350,000 Income Tax Expense [$240,000 + ($540,000 – $480,000)]........... Deferred Tax Asset ($1,200,000 × 40%)....................................... Deferred Tax Liability ($1,350,000 × 40%) ....................... Income Taxes Payable ($600,000 × 40%) ........................ 300,000 480,000 540,000 240,000 Ex. 19-122—Recognition of deferred tax asset. (a) (b) Describe a deferred tax asset. When is it not appropriate to recognize a portion or all of a deferred tax asset? Solution 19-122 (a) A deferred tax asset is the deferred tax consequences attributable to deductible temporary differences and operating loss carryforwards. It represents the increase in taxes refundable in future years as a result of deductible temporary differences existing at the end of the current year. Accounting for Income Taxes (b) 19 - 35 A deferred tax asset is recognized for all deductible temporary differences. However, a deferred tax asset should be reduced if, based on all available evidence, it is probable that some portion or all of the deferred tax asset will not be realized. 19 - 36 Test Bank for Intermediate Accounting, IFRS Edition, 2e Ex. 19-123—Permanent and temporary differences. Listed below are items that are treated differently for accounting purposes than they are for tax purposes. Indicate whether the items are permanent differences or temporary differences. For temporary differences, indicate whether they will create deferred tax assets or deferred tax liabilities. 1. Investments accounted for under the equity method. 2. Advance rental receipts. 3. Fine for polluting. 4. Estimated future warranty costs. 5. Excess of contributions over pension expense. 6. Expenses incurred in obtaining tax-exempt income. 7. Litigation accruals. 8. Excess tax depreciation over accounting depreciation. 9. Long-term construction contracts. 10. Percentage depletion of natural resources in excess of their cost. Solution 19-123 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Temporary difference, deferred tax liability. Temporary difference, deferred tax asset. Permanent difference. Temporary difference, deferred tax asset. Temporary difference, deferred tax liability. Permanent difference. Temporary difference, deferred tax asset. Temporary difference, deferred tax liability. Temporary difference, deferred tax liability. Permanent difference. Ex. 19-124—Permanent and temporary differences. Indicate and explain whether each of the following independent situations should be treated as a temporary difference or a permanent difference. (a) For accounting purposes, a company reports revenue from installment sales on the accrual basis. For income tax purposes, it reports the revenues by the installment method, deferring recognition of gross profit until cash is collected. (b) Pretax accounting income and taxable income differ because dividends received from other corporations was deducted from taxable income, while all of the dividends received was reported for financial statement purposes. (c) Estimated warranty costs (covering a three-year warranty) are expensed for accounting purposes at the time of sale but deducted for income tax purposes when paid. Accounting for Income Taxes 19 - 37 Solution 19-124 (a) Temporary difference. This difference in the timing of revenue recognition for pretax financial income and taxable income will initially increase pretax financial income, but will increase taxable income by the amount of deferred gross profits as cash is collected in subsequent years. Assuming the estimate as to collectibility of installment receivables is valid, the total amounts reported as gross profits for accounting purposes and for tax purposes will be equal over the life of the installment receivables. The time lag between the accrual for accounting purposes and the recognition for tax purposes will result in credit entries to a company's deferred tax liability as long as installment sales are level or increasing. The credit entries related to particular installment receivables will be "drawn down," or reversed, however, when the receivables are collected. (b) Permanent difference. This difference in pretax financial income and taxable income will never reverse because some countries’ tax laws allow a company that owns stock in another corporation to deduct the dividends it receives from that company. Taxes will not be paid on the dividends deducted and there are no tax consequences for those dividends, even though they are recognized as income for book purposes. (c) Temporary difference. The full estimated three years of warranty expenses reduce the current year's pretax financial income, but will reduce taxable income in varying amounts each year as paid. Assuming the estimate for each warranty is valid, the total amounts deducted for accounting and for tax purposes will be equal over the three-year period for each warranty. This is an example of an expense that, in the first period, reduces pretax financial income more than taxable income and, in later years, reverses and reduces taxable income without affecting pretax financial income. Ex. 19-125—Temporary differences. There are four types of temporary differences. For each type: (1) indicate the cause of the difference, (2) give an example, and (3) indicate whether it will create a taxable or deductible amount in the future. Solution 19-125 (a) Revenues or gains are taxable after they are recognized in financial income. Examples are installment sales, long-term construction contracts, and the equity method of accounting for investments. They result in future taxable amounts. (b) Revenues or gains are taxable before they are recognized in financial income. Examples are subscriptions received in advance and rents received in advance. They result in future deductible amounts. (c) Expenses or losses are deductible before they are recognized in financial income. Examples are excess depreciation, prepaid expenses, and pension funding in excess of pension expense. They result in future taxable amounts. (d) Expenses or losses are deductible after they are recognized in financial income. Examples are warranty expenses, estimated litigation losses, and unrealized holding loss on securities. They result in future deductible amounts. 19 - 38 Test Bank for Intermediate Accounting, IFRS Edition, 2e Ex. 19-126—NOL Carryback and Carryforward, Recognition versus Non-Recognition Lindemax Inc. reports the following pretax income (loss) for both financial reporting purposes and tax purposes. (Assume the carryback provision is used for a net operating loss.) Year Pretax Income (Loss) Tax Rate 2014 £220,000 34% 2015 180,000 34% 2016 (520,000) 38% 2017 440,000 38% The tax rates listed were all enacted by the beginning of 2014. Instructions (a) Prepare the journal entries for the years 2014-2017 to record income tax expense (benefit) and income tax payable (refundable) and the tax effects of the loss carryback and carryforward, assuming that the end of 2016 it is probable that the benefits of the loss carryforward will be realized in the future. (b) Using the assumption in (a), prepare the income tax section of the 2016 income statement, beginning with the line “Operating loss before income taxes.” (c) Prepare the journal entries for 2016 and 2017, assuming that based on the weight of available evidence, it is probable that one-fourth of the benefits of the loss carryforward will not be realized. Solution 19-126 (a) 2014 Income Tax Expense.................................................................... Income Taxes Payable (₤220,000 × 34%)......................... 74,800 2015 Income Tax Expense.................................................................... Income Taxes Payable (₤180,000 × 34%)......................... 61,200 2016 Income Tax Refund Receivable.................................................... Deferred Tax Asset....................................................................... Benefit Due to Loss Carryback......................................... Benefit Due to Loss Carryforward..................................... 74,800 61,200 136,000 45,600 136,000* 45,600** *[34% × ₤(220,000)] + [34% × ₤(180,000)] = ₤136,000 **38% × ₤(520,000  ₤220,000  ₤180,000) = ₤45,600 2017 Income Tax Expense.................................................................... Income Taxes Payable...................................................... Deferred Tax Asset............................................................ *[(₤440,000  ₤120,000) × 38%] = ₤121,600 167,200 121,600* 45,600 Accounting for Income Taxes 19 - 39 (b) Operating loss before income taxes............................................. ₤(520,000) Income tax benefit Benefit Due to Loss Carryback......................................... ₤136,000 Benefit Due to Loss Carryforward..................................... 45,600 181,600 Net loss........................................................................................ ₤(338,400) (c) 2016 Income Tax Refund Receivable.................................................... Deferred Tax Asset ........................................................ Benefit Due to Loss Carryback......................................... Benefit Due to Loss Carryforward..................................... 136,000 34,200 136,000* 34,200** *[34% × ₤(220,000)] + [34% × ₤(180,000)] = ₤136,000 **38% × [(₤520,000  ₤220,000  ₤180,000)] × 3/4 = ₤34,200 2017 Income Tax Expense ................................................................. Deferred Tax Asset............................................................ Benefit Due to Loss Carryforward (₤120,000 × .38 × 1/4).................................................. Income Taxes Payable [(₤440,000  ₤120,000) × .38)]..................................... 167,200 34,200 11,400 121,600 19 - 40 Test Bank for Intermediate Accounting, IFRS Edition, 2e PROBLEMS Pr. 19-127—Differences between accounting and taxable income and the effect on deferred taxes. The following differences enter into the reconciliation of financial income and taxable income of Abbott Company for the year ended December 31, 2014, its first year of operations. The enacted income tax rate is 30% for all years. Pretax accounting income Excess tax depreciation Litigation accrual Unearned rent revenue deferred on the books but appropriately recognized in taxable income Interest received on government obligations Taxable income 1. 2. 3. 4. $700,000 (320,000) 70,000 50,000 (20,000) $480,000 Excess tax depreciation will reverse equally over a four-year period, 2015-2018. It is estimated that the litigation liability will be paid in 2018. Rent revenue will be recognized during the last year of the lease, 2018. Interest received on government obligations is expected to be $20,000 each year until their maturity at the end of 2018. Instructions (a) Prepare a schedule of future taxable and (deductible) amounts. (b) Prepare a schedule of the deferred tax (asset) and liability. (c) Since this is the first year of operations, there is no beginning deferred tax asset or liability. Compute the net deferred tax expense (benefit). (d) Prepare the journal entry to record income tax expense, deferred taxes, and the income taxes payable for 2014. Solution 19-127 (a) 2015 Future taxable (deductible) amounts: Depreciation $80,000 Litigation Unearned rent (b) Temporary Differences Depreciation Litigation Unearned rent Totals (c) Deferred tax expense Deferred tax benefit Net deferred tax expense Future Taxable (Deductible) Amounts $320,000 (70,000) (50,000) $200,000 2016 2017 $80,000 $80,000 Tax Rate 30% 30% 30% $96,000 (36,000) $60,000 2018 Total $80,000 $320,000 (70,000) (70,000) (50,000) (50,000) Deferred Tax (Asset) Liability $96,000 $(21,000) (15,000) $(36,000) $96,000 Accounting for Income Taxes 19 - 41 Solution 19-127 (cont.) (d) Income Tax Expense ($144,000 + $60,000)................................. Deferred Tax Asset ...................................................................... Deferred Tax Liability ....................................................... Income Taxes Payable ($480,000 × 30%) ....................... 204,000 36,000 96,000 144,000 Pr. 19-128—Multiple temporary differences. The following information is available for the first three years of operations for Cooper Company: 1. Year 2014 2015 2016 Taxable Income $500,000 330,000 400,000 2. On January 2, 2014, heavy equipment costing $600,000 was purchased. The equipment had a life of 5 years and no residual value. The straight-line method of depreciation is used for book purposes and the tax depreciation taken each year is listed below: 2014 $198,000 2015 $270,000 Tax Depreciation 2016 2017 $90,000 $42,000 Total $600,000 3. On January 2, 2015, $240,000 was collected in advance for rental of a building for a threeyear period. The entire $240,000 was reported as taxable income in 2015, but $160,000 of the $240,000 was reported as unearned revenue at December 31, 2015 for book purposes. 4. The enacted tax rates are 40% for all years. Instructions (a) Prepare a schedule comparing depreciation for financial reporting and tax purposes. (b) Determine the deferred tax (asset) or liability at the end of 2014. (c) Prepare a schedule of future taxable and (deductible) amounts at the end of 2015. (d) Prepare a schedule of the deferred tax (asset) and liability at the end of 2015. (e) Compute the net deferred tax expense (benefit) for 2015. (f) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2015. Solution 19-128 (a) Year 2014 2015 2016 2017 2018 Depreciation for Financial Reporting Purposes $120,000 120,000 120,000 120,000 120,000 $600,000 Depreciation for Tax Purposes $198,000 270,000 90,000 42,000 -0$600,000 Temporary Difference $ (78,000) (150,000) 30,000 78,000 120,000 $ -0- 19 - 42 Test Bank for Intermediate Accounting, IFRS Edition, 2e Solution 19-128 (cont.) (b) 2015 Future taxable (deductible) amounts: Depreciation $(150,000) 2016 $30,000 2017 2018 Total $78,000 $120,000 $78,000 Deferred tax liability: $78,000 × 40% = $31,200 at the end of 2014. (c) Future taxable (deductible) amounts: Depreciation Rent 2016 2017 2018 Total $30,000 (80,000) $78,000 (80,000) $120,000 $228,000 (160,000) (d) Future Taxable (Deductible) Amounts $228,000 (160,000) $ 68,000 Temporary Differences Depreciation Rent Totals (e) (f) Tax Rate 40% 40% Deferred Tax (Asset) Liability $91,200 $(64,000) $(64,000) $91,200 Deferred tax asset at end of 2015 Less: Deferred tax asset at beginning of 2015 Deferred tax (benefit) $(64,000) -0$(64,000) Deferred tax liability at end of 2015 Less: Deferred tax liability at beginning of 2015 Deferred tax expense $91,200 31,200 $60,000 Deferred tax (benefit) Less: Deferred tax expense Net deferred tax benefit for 2015 $(64,000) 60,000 $ (4,000) Income Tax Expense ($132,000 – $4,000)................................... Deferred Tax Asset....................................................................... Deferred Tax Liability........................................................ Income Taxes Payable ($330,000 × 40%)......................... 128,000 64,000 60,000 132,000 Pr. 19-129—Deferred tax asset. Farmer Inc. began business on January 1, 2015. Its pretax financial income for the first 2 years was as follows: 2015 2016 $240,000 560,000 The following items caused the only differences between pretax financial income and taxable income. Accounting for Income Taxes 19 - 43 Pr. 19-129 (cont.) 1. In 2015, the company collected $180,000 of rent; of this amount, $60,000 was earned in 2015; the other $120,000 will be earned equally over the 2016–2017 period. The full $180,000 was included in taxable income in 2015. 2. The company pays a $10,000 fine for pollution. 3. In 2016, the company terminated a top executive and agreed to $90,000 of severance pay. The amount will be paid $30,000 per year for 2016–2018. The 2016 payment was made. The $90,000 was expensed in 2016. For tax purposes, the severance pay is deductible as it is paid. The enacted tax rates existing at December 31, 2015 are: 2015 2016 30% 35% 2017 2018 40% 40% Instructions (a) Determine taxable income for 2015 and 2016. (b) Determine the deferred income taxes at the end of 2015, and prepare the journal entry to record income taxes for 2015. (c) Prepare a schedule of future taxable and (deductible) amounts at the end of 2016. (d) Prepare a schedule of the deferred tax (asset) and liability at the end of 2016. (e) Compute the net deferred tax expense (benefit) for 2016. (f) Prepare the journal entry to record income taxes for 2016. Solution 19-129 (a) Pretax financial income Permanent differences: Fine Temporary differences: Rent Severance pay Taxable income (b) Future taxable (deductible) amounts: Rent Tax rate Deferred tax (asset) liability 2015 $240,000 2016 $560,000 10,000 250,000 10,000 570,000 120,000 -0$370,000 (60,000) 60,000 $570,000 2016 2017 Total $(60,000) X 35% $(21,000) $(60,000) X 40% $(24,000) $(120,000) Income Tax Expense ($111,000 – $45,000)................................. Deferred Tax Asset....................................................................... Income Taxes Payable ($370,000 × 30%)....................... $(45,000) at end of 2015 66,000 45,000 111,000 19 - 44 Test Bank for Intermediate Accounting, IFRS Edition, 2e Solution 19-129 (cont.) (c) Future taxable (deductible) amounts: Rent Severance pay (d) Temporary Difference Rent Severance pay Totals 2017 2018 Total $(60,000) (30,000) $(30,000) $(60,000) (60,000) Future Taxable (Deductible) Amounts $ (60,000) (60,000) $(120,000) Tax Rate 40% 40% (e) Deferred tax asset at end of 2016 Less: Deferred tax asset at beginning of 2016 Net deferred tax (expense) for 2016 (f) Income Tax Expense ($199,500 – $3,000)................................... Deferred Tax Asset....................................................................... Income Taxes Payable ($570,000 × 35%)......................... Deferred Tax (Asset) Liability $(24,000) (24,000) $(48,000) $(48,000) (45,000) $ (3,000) 196,500 3,000 199,500 Pr. 19-130—Interperiod tax allocation with change in enacted tax rates. Murphy Company purchased equipment for $180,000 on January 2, 2014, its first day of operations. For book purposes, the equipment will be depreciated using the straight-line method over three years with no salvage value. Pretax financial income and taxable income are as follows: 2014 2015 2016 Pretax financial income $224,000 $260,000 $300,000 Taxable income 200,000 260,000 324,000 The temporary difference between pretax financial income and taxable income is due to the use of accelerated depreciation for tax purposes. Instructions (a) Prepare the journal entries to record income taxes for all three years (expense, deferrals, and liabilities) assuming that the enacted tax rate applicable to all three years is 30%. (b) Prepare the journal entries to record income taxes for all three years (expense, deferrals, and liabilities) assuming that the enacted tax rate as of 2014 is 30% but that in the middle of 2015, the taxing authority raises the income tax rate to 35% retroactive to the beginning of 2015. Accounting for Income Taxes 19 - 45 Solution 19-130 (a) Book depreciation Tax depreciation Temporary difference 2014 2015 2016 (b) 2014 2015 2016 2014 $ 60,000 (84,000) $(24,000) 2015 $60,000 (60,000) $ -0- 2016 $60,000 (36,000) $24,000 Total $180,000 (180,000) $ -0- Income Tax Expense......................................................... Deferred Tax Liability ($24,000 × .30).................... Income Taxes Payable ($200,000 × .30)............... 67,200 Income Tax Expense......................................................... Income Taxes Payable ($260,000 × .30)............... 78,000 Income Tax Expense......................................................... Deferred Tax Liability........................................................ Income Taxes Payable ($324,000 × .30)............... 90,000 7,200 Income Tax Expense......................................................... Deferred Tax Liability ($24,000 × .30).................... Income Taxes Payable ($200,000 × .30)............... 67,200 Income Tax Expense......................................................... Deferred Tax Liability............................................. Income Taxes Payable ($260,000 × .35)............... 92,200 Income Tax Expense......................................................... Deferred Tax Liability........................................................ Income Taxes Payable ($324,000 × .35)............... 105,000 8,400 *Future taxable amount Deferred tax @ 30% Less: Deferred tax @ 35% Adjustment 2008 $24,000 7,200 8,400 $ 1,200 7,200 60,000 78,000 97,200 7,200 60,000 1,200* 91,000 113,400