Using Your Judgment 19-4 DeJohn Company, which began operations at the beginning

ID: 2453331 • Letter: U

Question

Using Your Judgment 19-4 DeJohn Company, which began operations at the beginning of 2012, produces various products on a contract basis. Each contract generates a gross profit of $84,000. Some of DeJohn’s contracts provide for the customer to pay on an installment basis. Under these contracts, DeJohn collects one-fifth of the contract revenue in each of the following four years. For financial reporting purposes, the company recognizes gross profit in the year of completion (accrual basis). For tax purposes, DeJohn recognizes gross profit in the year cash is collected (installment basis). Presented below is information related to DeJohn’s operations for 2014:

1. In 2014, the company completed seven contracts that allow for the customer to pay on an installment basis. DeJohn recognized the related gross profit of $588,000 for financial reporting purposes. It reported only $117,600 of gross profit on installment sales on the 2014 tax return. The company expects future collections on the related installment receivables to result in taxable amounts of $117,600 in each of the next four years. 2. In 2014, nontaxable municipal bond interest revenue was $26,400.

3. During 2014, nondeductible fines and penalties of $26,500 were paid.

4. Pretax financial income for 2014 amounts to $510,000.

5. Tax rates (enacted before the end of 2014) are 50% for 2014 and 40% for 2015 and later.

6. The accounting period is the calendar year.

7. The company is expected to have taxable income in all future years.

8. The company has no deferred tax assets or liabilities at the end of 2013. Prepare the journal entry to record income taxes for 2014.

What is DeJohn’s effective tax rate? (Round answer to 2 decimal places, e.g. 52.75.) Effective tax rate %

Explanation / Answer

Calculation of Accounting &Taxable income:

Particulars

Accounting

Taxable

Gross Profit

$588000

$117600

+ Non Taxable Municipal Bond Interest

$26400

+ Pretax Finance Income

$510000

- Non deductible Fines fines & penalties

-$26500

Net Profit

$1097900

$627600

Taxable Income = $627600

Tax Payable as per IT Act

= $627600 * 50%

=$313800

Gross profit has been recognized completely in the books whereas only 1/5th has been recognized for the purpose of tax and remaining amount has been deferred over next four years.

Hence, deferred tax liability should be created to the extent of tax on the installments to be collected i.e., on $470400 ($117600 * 4).

Remaining adjustments like municipal bond interest and fines & penalties are permanent in nature and hence deferred tax liability is not required to be created.

Tax as per the records

= ($627600 + $470400) * 50%

= $1098000 * 50%

=$549000

Deferred Tax Liability

= $470400 * 50%

=$235200

Journal Entry for income taxes for 2014:

Tax Expense a/c Dr $549000 -

To Tax Payable a/c - $313800

To Deferred Tax Liability - $235200

Effective Tax Rate:

=Tax Paid / Accounting Income

=$313800 / $1097900

=0.2858

=28.58 %

Effective Tax Rate = 28.58%