Chapter 16, Problem 16.16E

1.

To determine

Taxable Income

The amount of adjusted gross income which is liable to be taxed is known as taxable income

Deferred Tax

Deferred tax is an amount i.e. computed on the basis of tax liability on the income as per income statement and the income as per tax return, that difference is known as deferred tax. Deferred tax amount is deferred to the next financial year.

Deferred tax liability

When the Income Tax Expense account is less than the Income Tax Payable account, this difference is known as Deferred Tax Liability.

To determine: The amount necessary to record A’s income taxes for 2018 and prepare journal entry.

Explanation of Solution

Determine Income Tax Payable.

The following table shows the taxable income and income tax payable for the year 2018.

Particulars	Current Year	Future Taxable Amounts				Future Taxable Amounts
	2018	2019	2020	2021	2022	Total
($ in Millions)
Pre-tax accounting income	$33
Less: Advance rent payment	(8)	2	2	2	2	8
Taxable income	25
Enacted tax rate	$\times$ 40%					$\times$ 40%
Income tax payable	10(1)
Desired ending balance of deferred tax liability						3.2

Table (1)

Computation of deferred tax liability

The following table shows the amount of deferred tax liability to be recorded in the journal entry

Particulars	Amount ($) (in millions)
Desired ending balance of deferred tax liability	$3.2
Less: Beginning balance of deferred tax liability	(0)
Change in balance	$3.2(2)

Table (2)

The journal entry to record income taxes for 2018 is as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($) (in millions)	Credit ($) (in millions)
2018	Income Tax Expense (3)		13.2
	Deferred Tax Liability (2)			3.2
	Income Tax Payable (1)			10
	(To record the income tax in 2018)

Table (3)

Working Notes:

Compute income tax expense amount.

$\begin{array}{c}\text{Income tax expense=}\left(\text{Income tax payable +}\text{Deferred tax liability}\right)\\ \text{= \$10 million + 3}\text{.2million}\\ \text{=\$13}\text{.2}\text{million}\end{array}$ (3)

• Income Tax Expense is an expense account and it decreases the value of shareholders’ equity account. So, debit Income Tax Expense account with $13.2 million.
• Deferred tax liability is a liability and is increased by $3.2 million. Therefore, credit deferred tax liability account with $3.2 million.
• Income Tax Payable is a liability account has increased because the taxable income has increased. So, credit Income Tax Payable account with $10 million.

2.

To determine

The amount necessary to record A’s income taxes for 2019 and prepare journal entry.

Explanation of Solution

Determination of Income Tax Payable.

The following table shows the taxable income and income tax payable for the year 2019.

Particulars	Current Year	Future Taxable Amounts			Future Taxable Amounts
	2019	2020	2021	2022	Total
($ in Millions)
Pre-tax accounting income	$50
Advance rent payment	2	2	2	2	6
Taxable income	52
Enacted tax rate	$\times$ 40%				$\times$ 40%
Income tax payable	20.8(4)
Desired ending balance of deferred tax liability					2.4

Table (4)

Computation of deferred tax liability

The following table shows the amount of deferred tax liability to be recorded in the journal entry

Particulars	Amount ($) (in million)
Desired ending balance of deferred tax liability	$2.4
Less: Beginning balance of deferred tax liability	$(3.2)
Change in balance	$(0.8)(5)

Table (5)

The journal entry to record income taxes for 2019 is as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($) (in millions)	Credit ($) (in millions)
2019	Income Tax Expense (6)		20
	Deferred Tax Liability (5)		0.8
	Income Tax Payable (4)			20.8
	(To record the income tax in 2019)

Table (6)

Working Notes:

Compute income tax expense amount.

$\begin{array}{c}\text{Income tax expense=}\left(\text{Income tax payable +}\text{Deferred tax liability}\right)\\ \text{= \$20}\text{.8 million +}\left(\text{-0}\text{.8million}\right)\\ \text{=\$20}\text{million}\end{array}$ (6)

• Income Tax Expense is an expense account and it decreases the value of shareholders’ equity account. So, debit Income Tax Expense account with $20 million.
• Deferred tax liability is a liability and is decreased by $0.8 million. Therefore, debit deferred tax liability account with $0.8 million.
• Income Tax Payable is a liability account has increased because the taxable income has increased. So, credit Income Tax Payable account with $20.8 million.

3.

To determine

The amount necessary to record A’s income taxes for 2019 assuming that the new tax rate is 30% to be enacted from 2020 and prepare journal entry.

Explanation of Solution

Determination of Income Tax Payable.

The following table shows the taxable income and income tax payable for the year 2019.

Particulars	Current Year	Future Taxable Amounts			Future Taxable Amounts
	2019	2020	2021	2022	Total
($ in Millions)
Pre-tax accounting income	$50
Advance rent payment	2	2	2	2	6
Taxable income	52
Enacted tax rate	$\times$ 40%				$\times$ 30%
Income tax payable	20.8(7)
Desired ending balance of deferred tax liability					1.8

Table (7)

Computation of deferred tax liability

The following table shows the amount of deferred tax liability to be recorded in the journal entry

Particulars	Amount ($) (in million)
Desired ending balance of deferred tax liability	$1.8
Less: Beginning balance of deferred tax liability	$(3.2)
Change in balance	$(1.4)(8)

Table (8)

The journal entry to record income taxes for 2019 is as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($) (in millions)	Credit ($) (in millions)
2019	Income Tax Expense (9)		19.4
	Deferred Tax Liability (8)		1.4
	Income Tax Payable (7)			20.8
	(To record the income tax in 2019)

Table (9)

Working Notes:

Compute income tax expense amount.

$\begin{array}{c}\text{Income tax expense=}\left(\text{Income tax payable +}\text{Deferred tax liability}\right)\\ \text{= \$20}\text{.8 million +}\left(\text{-1}\text{.4million}\right)\\ \text{=\$19}\text{.4}\text{million}\end{array}$ (9)

• Income Tax Expense is an expense account and it decreases the value of shareholders’ equity account. So, debit Income Tax Expense account with $19.4 million.
• Deferred tax liability is a liability and is decreased by $1.4 million. Therefore, debit deferred tax liability account with $1.4 million.
• Income Tax Payable is a liability account has increased because the taxable income has increased. So, credit Income Tax Payable account with $20.8 million.

4.

To determine

To explain: The reason of having a difference in A’s income tax in 2019 when there is a change in the tax rate.

Explanation of Solution

The income tax expense of A in 2019 without the tax rate change was $20 million but after the tax rate has been reduced from 40% to 30% it reduced to $19.4 million in 2019 because the tax on future taxable amount of $6 million needs to be adjusted to $0.6 million $\left\{\text{\$6}\text{million}\text{×}\left(\text{40\%}\text{-}\text{30\%}\right)\right\}$ in 2019.

So, the income tax expense after the tax rate changed in 2019 is $19.4 million $\left(\text{\$20}\text{million}\text{-}\text{\$0}\text{.6}\text{million}\right)$.