2. Kara Fashions uses the straight-line depreciation for financial statement rep

Question

2. Kara Fashions uses the straight-line depreciation for financial statement reporting and MACRS for income tax reporting. Three years after its purchase, one of Kara’s buildings has a book value of $440,000 and a tax basis of $310,000. There were no other temporary differences and no permanent differences. Taxable income was $5 million and Kara’s tax rate is 40%. What is the deferred tax liability to be reported in the balance sheet? Assume that the deferred tax liability balance was $50,000 in the previous year.

Prepare the appropriate journal entry to record income taxes this year, please show how you came to the answer.

Explanation / Answer

Supposing life of the asset is 7 years and using straight line depreciation for book and for tax purpose MACRS 7 Years depreciation. Depreciation rate: 14.29,24.49,17.49,12.49,8.93,8.92,8.93,4.46. So, the original cost of the assets comes out to $770,000 as (440000 * 7/4 = $770,000).

Depreciation for the book value for the current year = 440000 / 4 = $110000

Depreciation for the tax purpose = 770000 *12.49% = $96173

Tax as per book value = 5000000 - 110000 = 4890000 * 0.40 = $1956000

Tax as per tax purpose = 5000000 - 96173 = $4903827 * 0.40 = $1961531

Journal entry:

Debit Income tax payable $1956000

Debit Deferred Tax Liability $ 5531

Credit Cash $1961531

the deferred tax liability to be reported in the balance sheet = $50000 - $5531 = $44469

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