4. The records for Good Co. show this data for 2013, the first y ear of the comp
ID: 2491761 • Letter: 4
Question
4. The records for Good Co. show this data for 2013, the first y ear of the company: Gross profit on installment sales recorded on the books was $200,000. Of this, only $150,000 was reported for tax purposes. Life insurance on officers was $3,800. Machinery was acquired in January for $300,000. Straight-line depreciation over a ten-year period (no salvage value) is used. For taxes, MACRS depreciation is used and Good may deduct 14% of the cost for 2013. Interest received on tax-exempt Iowa State bonds was $9,000. The estimated warranty liability on the books related to 2013 sale s was $19,600. Of this, only $13,600 could be deductible for tax purposes. The remainder will be incurred in 2014. Pretax financial income is $250,000. The tax rate is 30%. REQUIRED: (a) Prepare a schedule starting with pretax financial income and compute taxable income. (b) Calculate the amount of short-term and long-term deferred tax asset or liability that is requi red as of the end of 2013. (c) Prepare the journal entry to re cord income taxes for 2013. (d) Calculate net income for 2013. (e) Calculate the effective income tax rate for 2013. (f) Suppose that the Company believes it is not more likely than not that it will be able to realize its deferred tax asset due to future expected losses. What would GAAP requ ire the Company to do in this circumstance? (g) Suppose instead that the Company does expect to earn income in future years. Howe ver, it believes that its calculation of the book/tax difference associated with the installment sale is not likely to be sustained upon examination. What would GAAP require the Company to do in this circumstance? 5. The following information was taken from the books and records of Simonic, Inc.: (i) Net Income $ 560,000 (ii) Capital structure: (a) Convertible 6% bonds. Each of the 300 $1,000 bonds is convertible into 50 shares of common stock at the present date and for the next 10 years. $ 300,000 (b) $10 par common stock, 200,000 shares issued and outstanding during the entire year. $2,000,000 (c) Stock options outstanding to buy 16,000 shares of common stock at $20 per share. (iii) Other information: (a) Bonds converted during the year NONE (b) Income tax rate 30% (c)Average market price per share of common stock during year $32 (d) Warrants were outstanding the entire year (e) Warrants exercised during the year NONE REQUIRED: (a) Is the capital structure simple or complex? Explain. (b) Compute basic earnings per share. (c) Compute diluted earnings per share.
Explanation / Answer
a)
Pre tax financial income
$250,000.00
Permanent difference
Life insurance
$3,800.00
Interest exempted from tax
-$9,000.00
Temporary differences
Instalment sales
($200,000 - $150,000)
-$50,000.00
Extra depreciation
($42,000 - $30,000)
-$12,000.00
Warranties
($19,600 - $13,600)
$6,000.00
Taxable Income
$188,800.00
b)
Deferred tax asset = $6,000 * 0.30 = $1,800
Deferred tax liability = ($50,000 + $12,000) * 0.30 = $18,600
c)
Income tax payable = $188,800 * 0.30 = $56,640
Journal entry:
Income tax expense
$73,440.00
Deferred tax asset
$1,800.00
Deferred tax liability
$18,600.00
Income tax payable
$56,640.00
d)
Pre tax financial income = $250,000
Tax expense = $73,440
Net income = $250,000 - $73,440 = $176,560
e)
Effective income tax rate = $73,440 / $250,000 = 29.38%
f)
In this circumstance, company should offset the deferred tax asset by creating a valuation allowance.
g)
In this circumstance also, company should offset the deferred tax asset by creating a valuation allowance equal to $15,000 ($50,000 * 0.30).
Pre tax financial income
$250,000.00
Permanent difference
Life insurance
$3,800.00
Interest exempted from tax
-$9,000.00
Temporary differences
Instalment sales
($200,000 - $150,000)
-$50,000.00
Extra depreciation
($42,000 - $30,000)
-$12,000.00
Warranties
($19,600 - $13,600)
$6,000.00
Taxable Income
$188,800.00
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