Chen
Corporation reported income before taxes for the year ended December 31, 2011,
of $1,645,000. In preparing the 2011 financial statements, the accountant
discovered an error that was made in 2010. The error was that a piece of land
with a cost of $40,000 had been recognized as an operating expense in error.
The balance reported as retained earnings at December 31, 2010, was $5,678,000,
and the net book value of property, plant, and equipment (excluding land) was
$1,352,000 at the same date. During 2011, Chen Corporation acquired additional
equipment with a cost of $16,000.
In
completing the corporate tax return for the 2011 year, the company controller
noted that the 2011 depreciation expense was $365,000, CCA claimed was
$300,000, and non-deductible income tax penalties and interest of $2,500 and
golf club dues of $4,500 were incurred in the year. In addition, the accounting
allowance for doubtful accounts exceeded the tax reserve for uncollectible
amounts by $20,000, although they were equal at the beginning of the year. At
the end of 2010, the company had temporary differences of $135,000, due to
lower depreciation expense than CCA claimed on the corporate tax return. The
resulting future taxable amounts and the dates they were expected to reverse at
December 31, 2010, were:
2011
………………………$ 65,000
2012
……………………… 40,000
2013
……………………… 30,000
$135,000
The
tax rate is 35% for all years. Chen Corporation applies PE GAAP and uses the
future income taxes method of accounting.
Instructions
(a)
Calculate the balance sheet future tax account balance at December 31, 2010.
(b)
Determine the effect of the prior period error on the December 31, 2010 balance
sheet and prepare the journal entry to correct the error. Assume that the 2010
income tax return is refiled.
(c)
Prepare the journal entries to record income taxes for the 2011 year.
(d)
Indicate how the income taxes will be reported on the financial statements for
2011 by preparing the bottom portion of the income statement beginning with
“Income before income taxes.” Also prepare the Statement of Retained Earnings
for the year ended December 31, 2011, assuming no dividends were declared
during the year.
(a) $135,000 x 35% = $47,250, Future tax
liability, December 31. 2010.
(b) The prior period error has the
following effect on the December 31, 2010 balance sheet: The land is
understated by $40,000, retained earnings is understated by the $40,000 error
in the expenses on the 2010 income statement and overstated by the income tax
effect (35% of $40,000 = $14,000), and a future tax liability account is
understated by $14,000.
|
Account
|
Debit
|
Credit
|
|
Land
|
40,000
|
|
|
Retained
Earnings
|
|
40,000
|
|
Retained Earnings
|
14,000
|
|
|
Income
Taxes Payable
|
|
14,000
|
|
To recognize additional tax payable on the amount
deducted in error in 2010. (2010 tax return is refiled)
|
|
|
(c)
|
Accounting Income
|
$1,645,000
|
|
Add:
Golf Club Dues
Non deductible interest
costs
|
4,500
2,500
|
|
Depreciation expense
|
365,000
|
|
Excess of year’s bad debt
expense over tax deductible amount
|
20,000
|
|
Less: CCA
|
(300,000)
|
|
Taxable Income
|
$1,737,000
|
|
Asset / Liability
|
Carrying Amount
|
Tax Basis
|
Deductible / (Taxable) Temporary Difference
|
Tax Rate
|
Future Tax (Liability) Asset
|
|
Property, plant, and equipment
|
$1,352,000 + $16,000 – $365,000 = $1,003,000
|
933,000*
|
$ (70,000)
|
35%
|
$ (24,500)
|
|
Allowance for doubtful accounts
|
not given
|
not given
|
20,000
|
35%
|
7,000
|
|
Future tax liability, Dec. 31, 2011
Balance before adjustment
Adjustment required to FTL account & Future
income tax benefit, 2011
|
$(17,500)
(47,250)
$ 29,750
|
||||
|
*Carrying amount,
Dec. 31, 2010
|
|
$1,352,000
|
|
Future taxable amount, Dec. 31, 2010
|
|
( 135,000)
|
|
UCC, Dec. 31, 2010
|
|
1,217,000
|
|
2011 addition to class
|
|
16,000
|
|
Less 2011 CCA
|
|
( 300,000)
|
|
UCC, Dec. 31, 2011
|
|
$ 933,000
|
Current Income tax expense = $1,737,000 x 35% =
$607,950
Future Income Tax expense = $29,750 (benefit)
Total Income Tax expense = $607,950-29,750 = $578,200
|
Account
|
Debit
|
Credit
|
|
Current income tax expense
|
$607,950
|
|
|
Income tax
payable
|
|
$607,950
|
|
Future income tax liability
|
$29,750
|
|
|
Future
income tax benefit
|
|
$29,750
|
|
|
|
|
(d)
Income Statement:
|
Net income before income taxes
|
|
$ 1,645,000
|
|
|
Less: Income tax expense
|
|
|
|
|
|
Current income tax expense
|
$607,950
|
|
|
|
Future income tax benefit
|
(29,750)
|
578,200
|
|
Net Income
|
|
$1,066,800
|
|
Statement of Retained
Earnings:
|
Retained Earnings, January 1, 2011
|
|
|
|
|
As previously reported
|
$5,678,000
|
|
|
Correction of prior period error, net of income
taxes of $14,000
|
26,000
|
|
Restated balance of Retained Earnings
|
5,704,000
|
|
|
Add: Net Income
|
1,066,800
|
|
|
Retained Earnings, December 31, 2011
|
$6,770,800
|
|
