The following information is available for the first four years of operations fo

Question

The following information is available for the first four years of operations for a Company:

i.          Year                 Taxable Income          Tax Rate

            2017                $500,000                     40%

            2018                375,000                       38%

            2019                400,000                       38%

2020                450,000                       38%

ii. On January 1, 2017, heavy equipment costing $800,000 was purchased. The equipment had a life of 5 years and no salvage value. The straight-line method of depreciation is used for book[1*] purposes and the tax depreciation taken each year is listed below:

                                                Tax Depreciation                    

               2017               2018             2019                2020                 Total           

            $264,000         $360,000         $120,000         $56,000           $800,000

iii. On January 1, 2018, $360,000 was collected in advance for rental of a building for a three-year period. The entire $360,000 was reported as taxable income in 2018, but $240,000 of the $360,000 was reported as unearned revenue at December 31, 2018 for book purposes.

Prepare the journal entry to record income tax expense, deferred income taxes, and income tax payable for 2017.

Prepare the journal entry to record income tax expense, deferred income taxes, and income tax payable for 2018.

Prepare the journal entry to record income tax expense, deferred income taxes, and income tax payable for 2019.

[1*] Remember book purposes is same as financial reporting purposes

Explanation / Answer

When certain expenses/incomes are taken into the Statement of Profit and Loss of an entity during different time periods due to difference in the principles of accounting and taxation, a temporary difference arises in the amounts of taxes to be paid. This difference is referred to as the Deferred Tax Asset or Deferred Tax Liability.

This difference in the amount of tax payable does not mean any profit or loss to the entity. It just means that the amount is charged against profits of different years.

In the given problem,

The said asset is purchased for $800,000. Depreciation is charged there on at straight line method with 5 years useful life and zero salvage value. Hence, depreciation per year for the said asset for financial reporting purposes is $160,000.

Depreciation for the purpose of taxation is given. Also details for adjustment of rental income is given. From this information, we can build the following table.:

TABLE SHOWING ADJUSTMENT IN TAXABLE INCOME AND BALANCE OF DEFERRED INCOME TAX

TABLE SHOWING ADJUSTMENT TO DEFERRED INCOME TAX ACCOUNT DURING THE YEAR

JOURNAL ENTRIES

YEAR DEPRECIATION RENTAL INCOME NET DIFFERENCE TO BE ADJUSTED TO PROFIT BEFORE TAX (1)+(2) AS PER TAX AS PER BOOKS DIFFERENCE (1) AS PER TAX AS PER BOOKS DIFFERENCE (2) 2017 264,000 160,000 104,000 0 0 0 104,000 2018 360,000 160,000 200,000 120,000 360,000 (240,000) (40,000) 2019 120,000 160,000 (40,000) 120,000 0 120,000 80,000 2020 56,000 160,000 (104,000) 120,000 0 120,000 16,000

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