On
December 31, 2010, Quirk Inc. has taxable temporary differences of $2,200,000
and a future income tax liability of $924,000. These temporary differences are
due to Quirk having claimed CCA in excess of book depreciation in prior
years. Quirk’s year-end is December
31. At the end of December 2011, Quirk’s
substantially enacted tax rate for
2011
and future years was changed to 44%.
For
the year ended December 31, 2011, Quirk’s accounting loss before tax was
($494,000). The following data are also available.
1.
Pension expense was $87,000 while pension plan contributions were $111,000 for
the year (only actual pension contributions are deductible for tax).
2.
Business meals and entertainment were $38,000 (one-half deductible for tax
purposes).
3.
For the three years ending December 31, 2010, Quirk had cumulative, total
taxable income of $123,000 and total tax expense/taxes payable of $51,660.
4.
During 2011, the company booked estimated warranty costs of $31,000 and these
costs are not likely to be incurred until 2015.
5.
In 2011 the company incurred $150,000 of development costs (only 50% of which
are deductible for tax purposes).
6.
Company management has determined that only one-half of any loss carryforward
at the end of 2011 is more likely than not to be realized.
7.
In 2011, the amount claimed for depreciation was equal to the amount claimed
for CCA.
Instructions
Prepare
the journal entries to record taxes for the year ended December 31, 2011, and
the tax reconciliation note.
Prior year tax rate:
$924,000 / $2,200,000 = 42%
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Balance
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Deductible
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(PE GAAP)
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Sheet
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(Taxable)
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Future Tax
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Current
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Account
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Carrying
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Tax
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Temporary
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Tax
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Asset
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Long-
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Dec. 31, 2010
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Amount*
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Basis*
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Differences
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Rate
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(Liability)
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Term
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Property, plant, & equipment
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($2,200,000)
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42%
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($924,000)
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LT
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Future income tax
liability, December 31, 2011 ($2,200,000 x 44%)
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968,000
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Increase in future income
tax liability from December 31, 2010
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$44,000
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* not given in the problem
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Balance
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Deductible
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(PE GAAP)
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Sheet
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(Taxable)
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Future Tax
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Current
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Account
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Carrying
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Tax
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Temporary
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Tax
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Asset
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Long-
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Dec. 31, 2011
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Amount*
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Basis*
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Differences
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Rate
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(Liability)
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Term
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Pension liability
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($24,000)
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44%
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($10,560)
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LT
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Warranty liability
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31,000
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44%
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13,640
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C
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Increase in Pension Future
income tax liability for 2011
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(10,560)
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Increase in Warranty
Future income tax asset for 2011
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$13,640
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$
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* not given in the problem
Calculation of loss
for tax purposes and loss carryforward:
Accounting loss ($494,000)
Permanent differences:
Development
costs (50% X $150,000) 75,000
Meals and
entertainment (50% X $38,000) 19,000
Reversing differences:
Warranty expense 31,000
Pension
funding > expense (24,000)*
Loss for income tax purposes (393,000)
Carryback to prior years 123,000
Loss available for carryforward
(270,000)
50% more likely than not to be realized 50%
Portion of loss to recognize as benefit
(135,000)
Tax rate 44%
Future tax asset and current benefit ($59,400)
* ($87,000 – $111,000 = –$24,000)
2011 Income tax
journal entries:
Income Tax Recoverable ($123,000 x 42%). 51,660
Current Tax
Benefit – loss carryback 51,660
Future Income Tax Asset – loss carryforward 59,400
Current tax
benefit – loss carryforward 59,400
Future Income Tax Expense
($2,200,000
X (.44 –.42))........... 44,000
Future
Income Tax Liability......... 44,000
Future Income Tax Asset - warranty...... 13,640
Future
Income Tax Benefit........... 13,640
($31,000 X
.44 = $13,640)
Future Income Tax Expense – pension liability 10,560
Future
Income Tax Liability......... 10,560
($24,000 X
.44 = $10,560)
Income statement
(partial)
Loss before income taxes ($494,000)
Income
taxes
Current benefit –
loss carryback $51,660
Future benefit 18,480*
70,140
Net income ($423,860)
* ($59,400 – $44,000 + $13,640 – $10,560 = $18,480)
Reconciliation –
Statutory rate to effective rate:
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Divided by
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Accounting
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@ 44%
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loss
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Accounting loss
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$494,000
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$217,360
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44.00%
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Non-deductible half of
development costs
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75,000
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(33,000)
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(6.68%)
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Non-deductible portion of
meals/entertainment
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19,000
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(8,360)
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(1.69%)
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176,000
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35.63%
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Tax rate
adjustment on reversing differences ($2,200,000 x .02)
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2,200,000
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(44,000)
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(8.91%)
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½ of loss
carryforward not likely to recover
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135,000
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(59,400)
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(12.02%)
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Tax rate
adjustment on loss carryback ($123,000 x .02)
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123,000
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(2,460)
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(0.50%)
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$70,140
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14.20%
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Effective tax rate ($70,140 / $494,000 = 14.20%)
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14.20%
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Quirk Inc.’s effective tax rate differs from the
statutory rate due to permanent differences that will never be subject to tax;
a change in tax rate that impacts temporary differences that are being carried
forward; not recognizing the future tax benefit of half of the loss
carryforward; and, recovery of prior year income taxes at a tax rate different
than the current year rate.
