The following facts relate to Duncan
Corporation.
1. Deferred tax liability, January 1, 2008,
$60,000.
2. Deferred tax asset, January 1, 2008,
$20,000.
3. Taxable income for 2008, $105,000.
4. Cumulative temporary difference at
December 31, 2008, giving rise to future taxable amounts, $230,000.
5. Cumulative temporary difference at
December 31, 2008, giving rise to future deductible amounts, $95,000.
6. Tax rate for all years, 40%. No permanent
differences exist.
7. The company is expected to operate
profitably in the future.
Instructions
(a) Compute the amount of pretax financial
income for 2008.
(b) Prepare the journal entry to record
income tax expense, deferred income taxes, and income taxes payable for 2008.
(c) Prepare the income tax expense section of
the income statement for 2008, beginning with the line “Income before income
taxes.”
(d) Compute the effective tax rate for 2008.
(a) To complete a
reconciliation of pretax financial income and taxable income, solving for the
amount of pretax financial income, we must first
determine the amount of temporary differences arising or reversing
during the year. To accomplish that, we must determine the amount of cumulative
temporary differences underlying the beginning balances of the deferred tax
liability of $60,000 and the deferred tax asset of $20,000.
$60,000 ÷
40% = $150,000 beginning cumulative temporary difference. $20,000 ÷ 40% = $
50,000 beginning cumulative temporary difference.
Cumulative temporary difference at
12/31/08
which will result in future taxable amounts........................................................... $230,000
Cumulative temporary difference at
1/1/08
which will result in future taxable amounts........................................................... 150,000
Originating difference in 2008 which
will
result in future taxable amounts.............................................................................. $ 80,000
Cumulative temporary difference at
12/31/08
which will result in future deductible amounts......................... $ 95,000
Cumulative temporary difference at
1/1/08
which will result in future deductible amounts......................... 50,000
Originating difference in 2008 which
will
result in future deductible amounts............................................ $ 45,000
Pretax financial income.................................................................... $ X
Originating difference which will
result in future
taxable amounts............................................................................. (80,000)
Originating difference which will
result in future
deductible amounts....................................................................... 45,000
Taxable income for 2008.................................................................. $105,000
Solving for pretax financial income:
X – $80,000 + $45,000 =
$105,000
X = $140,000 = Pretax
financial income
(b) Income Tax Expense......................................................................... 56,000
Deferred Tax Asset............................................................................. 18,000
Income Tax Payable................................................................. 42,000
($105,000 X 40%)
Deferred Tax Liability............................................................... 32,000
|
Temporary Difference
|
Future Taxable
(Deductible) Amounts
|
Tax Rate
|
Deferred Tax
|
|
|
(Asset)
|
Liability
|
|||
|
First one
|
($230,000
|
40%
|
|
$92,000
|
|
Second one
|
(
(95,000)
|
40%
|
$(38,000)
|
|
|
Totals
|
$135,000
|
|
$(38,000)
|
$92,000*
|
*Because of a flat tax rate, these
totals can now be reconciled:
$135,000
X 40% = $(38,000) + $92,000.
Deferred tax liability at the end of
2008.......................................... $92,000
Deferred tax liability at the
beginning of 2008.............................. 60,000
Deferred tax expense for 2008 (net
increase
required in deferred tax liability).................................................. $32,000
Deferred tax asset at the end of 2008.......................................................................... $
38,000
Deferred tax asset at the beginning of
2008............................................................... 20,000
Deferred tax benefit for 2008 (net
increase
required in deferred tax asset)................................................................................... $(18,000)
Deferred tax expense for 2008...................................................................................... $
32,000
Deferred tax benefit for 2008......................................................................................... (18,000)
Net deferred tax expense (benefit) for
2008................................................................. 14,000
Current tax expense for 2008
(Income tax payable)................................................................................................... 42,000
Income tax expense for 2008........................................................................................ $ 56,000
(c) Income before income taxes................................................................. $140,000
Income tax expense
Current............................................................................................. $42,000
Deferred............................................................................................ 14,000 56,000
Net income............................................................................................... $ 84,000
(d) Because of the
same tax rate for all years involved and no permanent differences, the
effective rate should equal the statutory rate. The following calculation
proves that it does: $56,000 ÷ $140,000 = 40% effective tax rate for 2008.
