Question

On January 1, 2017, Abbey acquires 90 percent of Benjamin's outstanding shares. Financial information for these two companies for the years of 2017 and 2018 follows:

Abbey Company:

   2017 2018

Sales	$     (776,000)	$ (1,114,000)
Operating expenses	488,000	674,000
Intra-entity gross profits in ending inventory (included in
above figures)	(137,000)	(164,000)
Dividend income—Benjamin Company	(18,000)	(36,000)

Benjamin Company:

Sales	(207,000)	(330,000)
Operating expenses	121,000	191,000
Dividends paid	(20,000)	(40,000)

Assume that a tax rate of 40 percent is applicable to both companies :

1. On consolidated financial statements for 2018, what are the income tax expense and the income tax currently payable if Abbey and Benjamin file a consolidated tax return as an affiliated group?
2. On consolidated financial statements for 2018, what are the income tax expense and income tax currently payable if they choose to file separate returns?

a. Income tax expense

   Income tax payable

b. Income tax expense

   Income tax payable

Answer 1

Part A

Consolidated Returns: 2018

Abbey income 2018 (sales less expenses)...............$440000

Benjamin income 2018 (sales less expenses)..........139000,

Numbers may differ from below, refer the points.

2017 gain realized in 2018........................................185,000 2018 deferred gain ..........................................(232000)

Taxable income ..............................................$500000

Tax rate .............................................40%

Income tax payable current ...................................$200000

Part B

On its separate tax return, Abbey will report taxable income of $430,000 the unrealized gains cannot be deferred. The dividends would not be taxable because Benjamin still meets the criteria to be a member of an affiliated group. A consolidated return is not a requirement for these dividends to be excluded. Thus, income taxes payable by Abbey would be $172,000 ($430,000, 40%). To determine the income tax expense for Abbey, the two temporary differences must be taken into account:

Taxable income ................................................$430,000

Gain taxed in 2017 although realized in 2018..............172,000

Gain taxed in 2018 although not yet realized .........(232,000)

2018 realized income subject to taxation ................$370,000 Tax rate ..........................................................................40%

Income tax expense ......................................$148,000

The $24,000 difference between the expense and the payable is the tax effect on the net unrealized gain ($60,000, 40%).

Benjamin will have an expense and payable of $46,800 ($117000, 40%).