Question

For its first year if operations, Altitude Inc. reports pretax GAAP income of $100,000 in 2020. Assume pretax income in 2021 and 2022 of $125,000 and $90,000 respectively. The enacted income tax rate in all years is 25%. The following additional information is available for the first three years of operation (with the exception of the one item in the 4th year).

• Prepaid rent in the amount of $20,000 was recorded on December 21, 2020 for 2021 rent.
• A warranty accrual of 30,000 was recorded on December 31, 2020. The warranty was paid evenly over the years 2021-2023.
• The company recorded interest revenue of $500 each of the three years on municipal bonds.

1. Compute the income tax payable each year for 2020, 2021, 2022
2. Determined the balance of any deferred tax assets or deferred tax liabilities at the end of each year (2020, 2021, 2022)
3. Record the journal entry related to taxes in 2020, 2021, 20222

Answer 1

Calculation of taxable income and tax liability	2020	2021	2022
Particulars	Amount ($)	Amount ($)	Amount ($)
Pretax Income as per GAAP	100000	125000	90000
Add: Incomes taxable and expenses inadmissible
Prepaid rent	20000
Warranty claims	30000
Less: Incomes non-taxable and expenses admissible
Prepaid rent		20000
Warranty claims		10000	10000
Interest on municipal bonds	500	500	500
Taxable income	149500	94500	79500
Tax liability @ 25%	37375	23625	19875
Deferred tax asset(DTA) and Deferred Tax liability (DTL)	DTA / DTL	Amount	Tax effect (@ 25%)
For the year ended December 31, 2020
Prepaid rent (Added back resulting in higher taxable income)	DTA	20000	5000
Warranty claims (Added back resulting in higher taxable income)	DTA	30000	7500
Total	DTA		12500
For the year ended December 31, 2021
Prepaid rent (Deducted resulting in lower taxable income) or reversal of existing DTA	DTL (Reversal of existing DTA)	20000	5000
Warranty claims (Deducted resulting in lower taxable income) or reversal of existing DTA	DTL (Reversal of existing DTA)	10000	2500
Total reversal of DTA			7500
For the year ended December 31, 2021
Warranty claims (Deducted resulting in lower taxable income) or reversal of existing DTA	DTL (Reversal of existing DTA)	10000	2500
Total reversal of DTA			2500
Interest on municipal bonds is permanent difference. Hence, no DTL or DTA

	Journal entries related to taxes:
Date	Particulars	Debit ($)	Credit ($)
12/31/2020	Income tax expense	37375
	Income tax payable		37375
	To record income taxes payable
	Income tax payable	37375
	Cash at Bank		37375
	To record payment of Income tax
	Deferred tax asset	12500
	Deferred tax (Income)		12500
	To record deferred tax assets
12/31/2021	Income tax expense	23625
	Income tax payable		23625
	To record income taxes payable
	Income tax payable	23625
	Cash at Bank		23625
	To record payment of Income tax
	Deferred tax expense	7500
	Deferred tax asset		7500
	To reverse the deferred tax asset recognised
12/31/2022	Income tax expense	19875
	Income tax payable		19875
	To record income taxes payable
	Income tax payable	19875
	Cash at Bank		19875
	To record payment of Income tax
	Deferred tax expense	2500
	Deferred tax asset		2500
	To reverse the deferred tax asset recognised