Chapter 18, Problem 12P

1

To determine

Explain the manner of reporting deferred tax items in the balance sheet of Company D as on December 31, 2015.

Explanation of Solution

Balance sheet: Balance Sheet is one of the financial statements that summarize the assets, the liabilities, and the Shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

Prepare balance sheet of Company D as on December 31, 2015:

Company D
Balance sheet (partial)
As on December 31, 2015
Assets	Amount
Current assets:
Deferred tax asset (net) (2)	$2,700
Liabilities and equity
Non- Current liabilities:
Deferred tax liability (net) (1)	$7,500

Table (1)

Thus, the current asset and non-current liabilities as on December 31, 2015 for Company D are $2,700 and $4,800 respectively.

Working Note 1: Determine the Deferred tax asset (net):

$\begin{array}{c}\text{Deferred tax liability }\left(\text{net}\right)\text{=Deferred tax asset (current) }-\text{Deferred tax liability (current)}\\ \text{= \$8,400}-\$5,700\\ =\text{ \$2,700}\end{array}$

Working Note 2: Determine the Deferred tax liability (net):

$\begin{array}{c}\text{Deferred tax liability }\left(\text{net}\right)\text{=}\left[\begin{array}{l}\text{Deferred tax liability}\\ \left(\text{non-current}\right)\end{array}\right]-\left[\begin{array}{l}\text{Deferred tax asset}\\ \left(\text{non-current}\right)\end{array}\right]\\ \text{= \$17,700}-\$10,200\\ =\text{ \$4,800}\end{array}$

2.

To determine

Prepare journal entry to rectify the deferred tax item of Company D.

Explanation of Solution

Change in tax rate: Change in tax rate is a usual practice in corporate world. When the change in tax rate takes place, the company has to adjust its deferred tax amount in order to achieve its desire ending balance.

Prepare journal entry to rectify the deferred tax item of Company D:

Date	Accounts title and explanation	Post Ref.	Debit	Credit
2016
April 30	Income Tax Expense (balancing figure)		$1,600
	Deferred Tax Asset - 1 (3)		$2,800
	Deferred Tax Asset - 2 (4)		$3,400
	Deferred Tax Liability - 3  (5)			$1,900
	Deferred Tax Liability - 4 (6)			$5,900
	(To record the income tax expense and deferred tax adjustment)

Table (2)

• Income Tax Expense is a component of stockholders’ equity and decreases, so debit it for $1,600.
• Deferred Tax Asset is an asset and increases, so debit it for $2,800.
• Deferred Tax Asset is an asset and increases, so debit it for $3,400.
• Deferred Tax Liability is a liability and increases, so credit it for $1,900.
• Deferred Tax Liability is a liability and increases, so credit it for $5,900.

Working note 3: Determine the deferred tax asset - 1:

  

Particulars	Amount
Future deductible amount at December 31, 2015 $\left(\frac{\$8,400}{0.30}\right)$	$28,000
Adjusted deferred tax asset $\left(\$28,000\times 0.40\right)$	$11,200
Less: Beginning balance of deferred tax asset	($8,400)
Adjusted deferred tax asset	$2,800

Table (3)

Working note 4: Determine the deferred tax asset - 2:

Particulars	Amount
Future deductible amount at December 31, 2015 $\left(\frac{\$10,200}{0.30}\right)$	$34,000
Adjusted deferred tax asset $\left(\$34,000\times 0.40\right)$	$13,600
Less: Beginning balance of deferred tax asset	($10,200)
Adjusted deferred tax asset	$3,400

Table (4)

Working note 5: Determine the deferred tax liability - 3:

Particulars	Amount
Future taxable amount at December 31, 2015 $\left(\frac{\$5,700}{0.30}\right)$	$19,000
Adjusted deferred tax liability $\left(\$19,000\times 0.40\right)$	$7,600
Less: Beginning balance of deferred tax liability	($5,700)
Adjusted deferred tax liability	$1,900

Table (5)

Working note 6: Determine the deferred tax liability - 4:

Particulars	Amount
Future taxable amount at December 31, 2015 $\left(\frac{\$17,700}{0.30}\right)$	$59,000
Adjusted deferred tax liability $\left(\$59,000\times 0.40\right)$	$23,600
Less: Beginning balance of deferred tax liability	($17 ,700)
Adjusted deferred tax liability	$5,900

Table (6)

3.

To determine

Record the income tax entry for Company D.

Explanation of Solution

Income Tax Expenses: The expenses which are related to the taxable income of the individuals and business entities for an accounting period, and are recognized by them for the purpose of federal government and state government tax are called as income tax expenses.

Record the income tax entry for Company D.

Date	Accounts title and explanation	Post Ref.	Debit	Credit
2016
December 31	Income Tax Expense (balancing figure)		$25,800
	Deferred Tax Asset - 2		$1,400
	Deferred Tax Liability - 3		$600
	Income Tax Payable (7)			$25,000
	Deferred Tax Asset - 1			$2,300
	Deferred Tax Liability- 4			$500
	(To record income tax expense with pre-tax income allocation)

Table (7)

• Income Tax Expense is a component of stockholders’ equity and it is decreased. So, debit it for $25,800.
• Deferred Tax Asset-2 is an asset and it is increased. Thus, debit for $1,400$\left(\$15,000-\$13,600\right)$.
• Deferred Tax Liability-3 is a liability and it is decreased, so debit it for $600$\left(\$7,000-\$7,600\right)$.
• Income Tax payable is a liability and it is increased. Thus, credit it for $25,000.
• Deferred Tax Liability-4 is a liability and increased, so credit it for $2,300$\left(\$25,900-\$23,600\right)$.
• Deferred Tax Asset is an asset and it is decreased, so credit it for $5,900$\left(\$10,700-\$11,200\right)$.

Working note 7: Compute the income tax payable:

$\begin{array}{c}\text{Income tax payable}=\text{Taxable income}\times \text{Corporate tax rate}\\ =\$62,500\times 40\%\\ \text{=\$25,000}\end{array}$

4.

To determine

Explain the manner of reporting income tax disclosures in the balance sheet of Company D.

Explanation of Solution

Deferred tax asset: When Income Tax Expense account is more than the Income Tax Payable account, this difference is known as Deferred Tax Asset.

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

Prepare balance sheet of Company D as on December 31, 2016:

Company D
Balance sheet (partial)
As on December 31, 2016
Assets	Amount
Current assets:
Deferred tax asset (net) (8)	$3,700
Liabilities and equity
Current liabilities:
Income taxes payable (7)	$25,000
Non- Current liabilities:
Deferred tax liability (9)	$10,900

Table (8)

Thus, the current assets, current liabilities and non-current liabilities are  as on December 31, 2016 for Company D are $3,700 , $25,000, and $10,900 respectively.

Working Note 8: Determine the non-current deferred tax liability:

$\begin{array}{c}\begin{array}{l}\text{Current deferred }\\ \text{tax asset}\end{array}\}\text{ =}\left(\begin{array}{l}\text{Ending deferred}\\ \text{ tax asset}\left(\text{current}\right)\end{array}\right)-\left(\begin{array}{l}\text{Ending deferred}\\ \text{ tax liability}\left(\text{current}\right)\end{array}\right)\\ \text{= \$10,700}-\$7,000\\ =\text{\$3,700}\end{array}$

Working Note 9: Determine the non-current deferred tax liability:

$\begin{array}{c}\begin{array}{l}\text{Non-current deferred}\\ \text{ income taxes}\end{array}\}\text{ =}\left(\begin{array}{l}\text{Ending deferred}\\ \text{ tax liability}\left(\text{non-current}\right)\end{array}\right)-\left(\begin{array}{l}\text{Ending deferred}\\ \text{ tax asset }\left(\text{non-current}\right)\end{array}\right)\\ \text{= \$25,900}-\$15,000\\ =\text{\$10,900}\end{array}$

5.

To determine

Determine the total income tax expense for 2016.

Explanation of Solution

Determine the total income tax expense for 2016:

Particulars	Amount
Income tax entry on December 31, 2016	$25,800
Add: Adjustment made on April 30, 2016	$1,600
Income tax expense for 2016	$27,400

Table (9)

Thus, the total income tax expense for 2016 is $27,400.