Question

Requirements:

1. Prepare Journal Entry to record income tax expense, deferred taxes, and income taxes payable for 2018.

2. Draft the income tax expense section of the Income Statement, beginning with "Income before income taxes".

3. Write an analysis directed toward the team at Good Company describing what the numbers mean and how they relate to the business.

Information:

Good Company began operations in 2018 and has provided the following information:

1. Pretax financial income for 2018 is $200,000

2. The tax rate enacted for 2018 and future years is 40%

3. Differences between the 2018 income statement and tax return are listed below:

a. Warranty expense accrued for financial reporting purpose amounts to $10,000. Warranty deductions per tax return amount to $4,000.

b. Gross profit on construction contracts using the percentage of completion method for book purposes amounts to $184,000. Gross profit on construction contracts for tax purposes amounts to $124,000.

c. Depreciation of property, plant, and equipment for financial reporting purposes amounts to $60,000. Depreciation of these assets amounts to $80,000 for the tax return.

d. A $3,500 fine paid for violation of pollution laws was deducted in computing pretax financial incomes.

e. Interest revenue earned on an investment in tax-exempt municipal bonds amounts to $1,400.

4. Taxable income is expected for the next few years.

Please include your working notes.

Thanks!

Answer 1

1. As per AS 22  deferred tax arises due to temporary differences.

The basic equation to recognize Tax expense is as follows.

Tax Expense = Current Tax + Deferred Tax

Total Tax Expense = $ 80000

Current Tax = $ 51240

Deferred Tax Liability = $28760

Journal Entries

a) & b) Profit & Loss A/c ................Dr 80000 ---

To Income Tax -- 51240

To Deferred tax Liability -- 28760

c) Income Tax A/c.......................Dr 51240 --

To Income Tax Payable -- 51240

2)

Computation of Taxable income
		Amount in $
	Profit before tax as per books of accounts	200000
Add:	Warranty Expenses not allowed for tax purpose but allowed in future years. (10000-4000)	6000
	Fine paid for violation of traffic rules not allowed for tax purpose is to be added to back	3500
Less:	Excess profit on construction contract to be shown in future years for tax purpose (184000-124000)	60000
	Additional depreciation to be provided for tax purpose (80000-60000)	20000
	Interest income exempted on municipal bonds not taxable	1400
	Income taxable under income tax	128100
	Tax @40% as per income tax	51240
	Tax on accounting income as per books (200000*40%)	80000

3) Deferred tax liability arise due to accounting is more than taxable income and that need to be paid in the future period.

Deferred tax arise due to two reasons one for temporary & another for permanent

Temporary differences are those which are capable of reversal of in one or more periods.

whereas permanent differences can not be adjusted.

We have to show the net off deferred tax asset or deferred tax liability in the balance sheet. both will not appear in the balance sheet either deferred tax asset or liability will appear in balance sheet.