Aaron
Engines Ltd. operates small engine repair outlets and is a tenant in several of
Tran Holdings Inc.'s strip shopping malls. Aaron signed several lease renewals
with Tran that each called for a three-month rent-free period. The leases start
at various dates and are for three to five years each. As with all of Tran's
tenants, Aaron pays rent quarterly, three months in advance, and records the
payments initially to Prepaid Rent.
The
rent-free period obtained in the lease agreement with Tran Holdings Inc.
reduces the overall rental costs of the outlets over the term of each lease.
Aaron's accounting policy requires the leasing costs of each outlet to be
allocated evenly over the term of the lease to fairly match expenses with
revenues. Aaron accrues rent expense during the rent-free period to an account
called Rent Payable. Following the rent-free period, the Rent Payable account
is amortized to Rent Expense over the remaining term of the lease. For tax
purposes, Aaron must use the cash basis and is unable to deduct the rent
expense accrued during the rent-free periods. On its tax return, Aaron can only
deduct the actual rent payments when they are made.
The
balances for the accounts related to prepaid rent and rent payable under leases
as well as payments for interest to earn tax-exempt income and payments for
golf club dues for the years ending December 31, 2013 and 2012, follow:
In
2012, Aaron’s tax rate is 43%, and it is 42% for subsequent years. Income
before income tax for the year ended December 31, 2012, was $884,000. During
2013, Aaron’s tax rate changed to 44% for 2013 and subsequent years. Income before
income tax for the year ended December 31, 2013, was $997,000.
Instructions
(a)
Calculate the future income tax asset or liability balances at December 31,
2012 and 2013.
(b)
Calculate taxable income and income taxes payable for 2012 and 2013.
(c)
Prepare the journal entries to record income taxes for 2012 and 2013.
(d)
Prepare a comparative income statement for 2012 and 2013, beginning with the line
“Income before income taxes.”
(e)
Provide the comparative balance sheet presentation for any resulting future tax
balance sheet accounts at December 31, 2012 and 2013. Be specific about the
classification.
(f)
Calculate the effective rate of tax for 2013. Provide a reconciliation and
explanation of why this differs from the statutory rate of 44%. Begin the
reconciliation with the statutory rate.
(g)
Repeat the balance sheet presentation in part (e) assuming Aaron follows IFRS.
(a)
2012:
|
Balance
|
|
|
Deductible
|
|
|
(PE GAAP)
|
|
Sheet
|
|
|
(Taxable)
|
|
Future Tax
|
Current
|
|
Account
|
Carrying
|
Tax
|
Temporary
|
Tax
|
Asset
|
or Long-
|
|
Dec. 31, 2012
|
Amount
|
Basis
|
Differences
|
Rate
|
(Liability)
|
Term
|
Prepaid Rent
|
$89,000
|
0
|
($89,000)
|
42%
|
($37,380)
|
C
|
Rent Payable
|
146,000
|
0
|
146,000
|
42%
|
61,320
|
LT
|
|
Future income tax asset,
December 31, 2012
Future income tax asset before
adjustment
Incr. in future income tax
asset and future income tax benefit for 2012
|
23,940
0
$ 23,940
|
|
||||
2013:
|
Balance
|
|
|
Deductible
|
|
|
(PE-GAAP)
|
|
Sheet
|
|
|
(Taxable)
|
|
Future Tax
|
Current
|
|
Account
|
Carrying
|
Tax
|
Temporary
|
Tax
|
Asset
|
Long-
|
|
Dec. 31, 2013
|
Amount
|
Basis
|
Differences
|
Rate
|
(Liability)
|
Term
|
Prepaid Rent
|
$92,000
|
0
|
($92,000)
|
44%
|
($40,480)
|
C
|
Rent Payable
|
133,000
|
0
|
133,000
|
44%
|
58,520
|
LT
|
|
Future income tax asset,
December 31, 2013
Future income tax asset before adjustment
Decr. in future income tax asset and future income tax
expense for 2013
|
18,040
23,940
($ 5,900)
|
|
||||
(b)
2012:
|
Accounting income
|
|
$884,000
|
|
Permanent differences:
|
|
|
|
Golf Club Dues
|
$13,000
|
|
|
Interest incurred to earn exempt income
|
4,000
|
17,000
|
|
|
|
901,000
|
|
Reversing differences:
|
|
|
|
Prepaid rent deductible when paid
|
|
(89,000)
|
|
Accrued rent expense not yet deductible
|
|
146,000
|
Taxable
income
|
|
$958,000
|
|
Current income taxes at 43%
|
|
$411,940
|
2013:
|
Accounting income
|
|
$997,000
|
|
Permanent differences:
|
|
|
|
Golf Club Dues
|
$11,000
|
|
|
Interest incurred to earn exempt income
|
6,000
|
17,000
|
|
|
|
1,014,000
|
|
Reversing differences:
|
|
|
|
Excess of rent paid over rent expense recognized
|
|
|
|
($92,000 –
$89,000)
|
|
(3,000)
|
|
Excess of rent paid over rent expense recognized
|
|
|
($146,000 – $133,000)
|
|
(13,000)
|
Taxable
income
|
|
$998,000
|
|
Current income taxes at 44%
|
|
$439,120
|
(a)
2012 Journal entries:
Current Income Tax Expense.............. 411,940
Income Tax
Payable.................. 411,940
Future Income Tax Asset................. 61,320*
Future
Income Tax Liability......... 37,380*
Future
Income Tax Benefit........... 23,940
* Alternately debit
Future
Income Tax Asset/Liability... 23,940
2013
Journal entries:
Current Income Tax Expense.............. 439,120
Income Tax
Payable.................. 439,120
Future Income Tax Expense............... 5,900
Future Income
Tax Liability......... 3,100
Future
Income Tax Asset............. 2,800
* Alternately credit
Future
Income Tax Asset/Liability... 5,900
(d)
2013 2012
Income
before income taxes $997,000 $884,000
Income tax expense
Current 439,120 411,940
Future (Benefit) 5,900 (23,940)
445,020 388,000
Net
income $551,980 $496,000
(e) Refer to last two
columns in tables in part (a) above.
2013 2012
Non-current assets
Future
income tax asset $58,520 $61,320
Current liabilities
Future
income tax liability 40,480 37,380
Under PE GAAP, future tax assets and future tax
liabilities are segregated into current and non-current categories. The
classification of an individual future tax liability or asset as current or
non-current is determined by the classification of the asset or liability
underlying the specific temporary difference.
|
(f)
|
|
|
|
|
|
Divided by
|
||||
|
|
|
|
|
|
|
Accounting
|
||||
|
|
|
|
|
@ 44%
|
|
Income
|
||||
|
Accounting income
|
$997,000
|
|
$438,680
|
|
44.0%
|
|||||
|
Non-deductible dues
|
11,000
|
|
4,840
|
|
0.5%
|
|||||
|
Non-deductible interest
|
6,000
|
|
2,640
|
|
0.3%
|
|||||
|
|
|
|
|
446,160
|
|
44.8%
|
||||
|
Change in
tax rate ($146,000
– $89,000) × (44% – 42%)
|
57,000
|
|
(1,140)
|
|
(0.2%)
|
|||||
|
|
|
|
$445,020
|
|
44.6%
|
|||||
|
Effective tax rate ($445,020/$997,000)
|
|
|
|
44.6%
|
||||||
The effective tax rate differs from the statutory
rate because of the effect of the permanent differences of golf club dues and
interest, and because of the effect of the change in tax rate during the year
on the future tax accounts.
(g)
2013 2012
Non-current assets
Future income tax
asset $18,040** $23,940*
*($61,320 – $37,380 = $23,940)
**($58,520 – $40,480 = $18,040)
IFRS require that all deferred tax assets and
liabilities be reported as non-current items on
