The following
information relates to Pearline Corporation’s transactions during 2011, its
first year of operations.
1. Income before
taxes on the income statement for 2011 was $110,000.
2. In addition,
Pearline reported a loss due to the writedown of land of $46,000 for financial
reporting purposes.
3. Pearline reported
a tax-deductible financing charge of $5,700 on its 2011 statement of retained
earnings. The charge is for interest on a financial instrument that is legally
debt, but in substance is equity for financial reporting purposes.
4. The tax rate
enacted for 2011 and future years is 40%. Since this was Pearline Corporation’s
first taxation year, no instalments on account of income taxes were required or
paid by Pearline.
5. Differences
between the 2011 GAAP amounts and their treatment for tax purposes were as
follows:
(a) Warranty expense
accrued for financial reporting purposes amounted to $15,000. Warranty payments
deducted for taxes amounted to $12,000. Warranty liabilities were classified as
current on the balance sheet.
(b) Of the loss on
writedown of land of $46,000, 25% will never be tax deductible. The remaining
75% will be deductible for tax purposes evenly over the years from 2012 to
2014. The loss relates to the loss in value of company land due to
contamination.
(c) Gross profit on
construction contracts using the percentage-of-completion method for book
purposes amounted to $30,000. For tax purposes, gross profit on construction
contracts amounted to $0 as the completed-contract method is used and no
contracts were completed during the year. Construction costs amounted to
$270,000 during the year.
(d) Depreciation of
property, plant, and equipment for financial reporting purposes amounted to
$60,000. CCA charged on the tax return amounted to $80,000. The related
property, plant, and equipment cost $300,000 when it was acquired early in
2011.
(e) A $3,500 fine
paid for a violation of pollution laws was deducted in calculating accounting
income.
(f) Dividend revenue
earned on an investment was tax exempt and amounted to $1,400.
6. Taxable income is
expected for the next few years.
Pearline Corporation
follows the PE GAAP future income taxes method.
Instructions
(a)
Calculate Pearline Corporation’s future income tax asset or liability at December
31, 2011.
(b)
Calculate the taxable income for 2011. Show all details of the adjustments to
accounting income to arrive at taxable income.
(c)
Prepare the journal entry(ies) to record income taxes for 2011.
(d)
Prepare a partial 2011 income statement, beginning with “Income before income
taxes and extraordinary items.”
(e)
Prepare a statement of retained earnings for the year ended December 31, 2011,
assuming no dividends were declared in the year.
(f)
Show how the balance of the future income tax asset or liability account will
be reported on the December 31, 2011 balance sheet.
(g)
Calculate the effective rate of tax. Provide a reconciliation and explanation
of why this differs from the statutory rate of 40%. Begin the reconciliation
with the statutory rate.
(h)
How would your response to (f) change if Pearline Corporation followed IFRS?
(a)
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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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or 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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Warranty liability
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$3,000
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$0
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$3,000
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40%
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$1,200
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C
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Construction in process
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300,000*
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270,000
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(30,000)
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40%
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(12,000)
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C
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Property, plant, & equipment
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240,000
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220,000
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(20,000)
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40%
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(8,000)
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LT
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Land
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not given
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not given
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34,500**
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40%
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13,800
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LT
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Future income tax
liability, December 31, 2011
Future income tax liability
before adjustment
Incr. in future income tax
liability and future income tax expense for 2011
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(5,000)
0
($5,000)
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* (Construction costs $270,000 + Gross profit
$30,000)
** $46,000 X 75%
Total future income tax expense—2011 $
5,000
Future income tax benefit—$13,800 – $0
(13,800)
Future income tax expense $ 18,800
(b)
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Net
income
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Retained
Earnings
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Total
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Accounting income
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$64,000
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($5,700)
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$58,300
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Permanent difference:
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Non-taxable dividends
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(1,400)
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(1,400)
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Non-deductible fines
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3,500
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3,500
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Non-deductible loss in land
value
$46,000 X 25%
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11,500
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11,500
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Reversing differences:
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Warranties: excess of expense over
claims paid ($15,000 –
$12,000)
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3,000
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3,000
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Property, plant, and equipment: excess
of CCA over depreciation
expense
($80,000 – $60,000)
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(20,000)
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(20,000)
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Construction in Process: Excess of
reported construction profit
over
completed contract method
($30,000 – $0)
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(30,000)
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(30,000)
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Loss on land not deductible until future
years
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34,500
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_______
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34,500
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Taxable income
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$65,100
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($5,700)
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$59,400
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Current income taxes at 40%
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$26,040
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($2,280)
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$23,760
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(c)
Current Income Tax Expense.............. 26,040
Income Tax Payable.................. 23,760
Retained
Earnings (tax effect)...... 2,280
Future Income Tax Expense .............. 5,000
Future Income Tax
Liability......... 5,000*
*Alternately:
Future Income Tax Expense............... 18,800
Future Income Tax Asset (Warranty)...... 1,200
Future
Income Tax Liability (C.I.P.) 12,000
Future
Income Tax Liability (PP&E).. 8,000
Future Income Tax Asset (Land writedown) 13,800
Future
Income Tax Benefit........... 13,800
(d)
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Income statement
presentation:
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Income before income taxes
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$64,000
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Income taxes
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Current income taxes
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$26,040
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Future income taxes
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5,000
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31,040
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Net income
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$32,960
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(e)
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Statement of Retained
Earnings
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Balance January 1, 2011
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-0-
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Add: Net income
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$32,960
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Less: Financing charge
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($5,700)
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Less applicable taxes
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2,280
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(3,420)
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Balance December 31, 2011
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$29,540
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(f) Balance Sheet
Refer to last two columns of table in
(a).
Non-current assets
Future income tax asset ($13,800 –
$8,000) $5,800
Current liabilities
Income taxes
payable 23,760
Future income
tax liability ($12,000 – $1,200) 10,800
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.
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(g)
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Divided by
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Accounting
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@ 40%
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Income
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Accounting income
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$64,000
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25,600
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40.0%
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Non-taxable dividends
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(1,400)
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(560)
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(0.9)%
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Non-deductible fines
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3,500
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1,400
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2.2%
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Non-deductible land
writedown
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11,500
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4,600
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7.2%
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31,040
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48.5%
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Effective tax rate
($31,040 / $64,000)
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48.5%
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The effective tax rate differs
from the statutory rate in this case because of the effect of the permanent
differences of dividends, fines and 25% of the loss due to writedown of land.
(h) Balance Sheet
Current liabilities
Income taxes
payable $23,760
Non-current liabilities
Future income
tax liability 5,000
($10,800 – $5,800)
IFRS require that all deferred tax assets and
liabilities be reported as non-current items on a classified statement of
financial position.
