Question

SUPPLEMENTAL PROBLEM 19-1 (req. 1, 2, 3)

International Roofing Systems (IRS) Company began operations several years ago. At the end of 2017, the only existing temporary differences were the difference described in (e) and (f) below (hint: this creates balances at the end of 2017 in the deferred tax balance sheet accounts). In addition, there are four other tax differences arising in 2018 and 2019. These differences are as follows:

(a)   Interest revenue earned on an investment in tax-exempt municipal bonds is $34,000 each year.

(b)   In 2018, pretax financial income includes payments of fines for polluting of $100,000.

(c)   IRS began franchising its business at the beginning of 2018 and collected $30,000 of franchise fees for services to be rendered in the initial year and over the next several years. Franchise fees are reported when collected for tax purposes. For financial reporting purposes, franchise fees are recognized as revenue when services related to the franchise agreement are provided; these amounts are $20,000 in 2018 and $4,000 in 2019.

(d)   At July 1, 2018, IRS purchased a subsidiary that resulted in an amount of $600,000 being assigned to goodwill. For tax purposes, the goodwill is amortized and deducted over a 15-year period on a straight-line basis. For financial reporting purposes, goodwill is not amortized, but is required to be tested for impairment; at the end of 2018, IRS determined that goodwill is not impaired, but at the end of 2019, IRS determined that the goodwill has an impairment loss of $45,000.

(e)   Several years ago, IRS purchased equipment at a cost of $200,000. For financial accounting purposes, straight-line depreciation over the estimated useful life of 10 years is used. For tax purposes, the MACRS system is used and the equipment falls in the 7-year recovery class. As of the end of 2017, the accounting basis for the carrying value was $120,000 and the tax basis was $62,480. For 2018 and 2019, the MACRS rates for depreciation are 8.93% and 8.92%, respectively.

(f)    IRS has a defined benefit pension plan for its employees. For financial reporting purposes, the accrual basis is used and for tax purposes, pension costs are deducted as funding contributions to the plan are paid. As of the end of 2017, pension expense for financial reporting has been $200,000 greater than funding contributions. Pension expense for financial reporting purposes is $42,000 in 2018 and $50,000 in 2019, and the amount deducted for tax purposes is $2,000 in 2018 and $5,000 in 2019.

Additional information:

ü Pretax financial income $180,000 for 2018 and $210,000 for 2019.

ü The enacted tax rate, effective in 2018, is 25%.

ü As of the end of each year, management estimates that it is more likely than not that future deductible amounts will not be realized as follows: 2017: $10,000; 2018: $12,000; 2019: $15,000

REQUIRED:

(1)   Complete year-by-year schedules through 2019 for each temporary difference showing the book amount, tax amount, current year taxable (deductible) amount, and future taxable (deductible) amount; note that for (e) and (f), you will need to start your schedule with the future taxable (deductible) amount as of the end of 2017.

(2)   Prepare schedules to reconcile between pretax financial income and taxable income for 2018 and 2019. Classify the tax differences as permanent or temporary.

(3)   Prepare journal entries to record the current portion of income tax expense for 2018 and 2019.

Answer 1

FUTURE TAXABLE (DEDCUTIBLE) AMOUNT AT THE END OF YEAR 2017

1. TEMPORARY DIFFERNCE OF DEPRECIATION ON ASSET

DEPRECIATION CHARGED IN INCOME TAX UP TO 2017 = 137520

DEPRICIATION CHARGED IN PROFIT & LOSS ACCOUNT = 80000

EXCESS DEPRECIATION CHARGED IN INCOME TAX = 57520

FUTURE TAXABLE AMOUNT= 57520

2. TEMPORARY DIFFERNCE OF PENSION FUND

PENSION FUND CHARGED IN INCOME TAX UP TO 2017 IS LESS THAN PENSION FUND CHARGED IN PROFIT & LOSS = 200000.

FUTURE DEDUCTIBLE AMOUNT = 200000

NET FUTURE DEDUCTIBLE AMOUNT = 200000-57520-10000

132480

S.NO.	PARTICULARS	BOOK AMOUNT	TAX AMOUNT	CURRENT TAXABLE (DEDCUCTIBLE) AMOUNT	FUTURE TAXABLE (DEDCUCTIBLE) AMOUNT	CLASSIFICATION
	OPENING BALNCE				(132480)
(A)	INTEREST INCOME EARNED ON EXEMPT MUNICIPAL BONDS	34000	0	0	0	THIS IS PERMANANT DIFFERNCE BECAUSE THIS INCOME WILL NEVER GET TAXED IN INCOME TAX AS THE INCOME EARNED IS EXEMPT.
(B)	PAYMENT OF FINE FOR POLLUTING	(100000)	0	0	0	THIS IS PERMANANT DIFFERNCE BECAUSE IN INCOME WE CAN NOT CLAIM BENEFIT FOR PAYMENT OF FINE FOR BREACHING ANY LAW.
(C)	FRANCHISEE INCOME RECEIVED IN 2018 BUT CHARGED IN BOOKS AS PER SERVICES RENDERED	20000	30000		(10000)	THIS IS TEMPORARY DIFFERNCE BECAUSE FRANCHISEE INCOME IS TAXED WHOLLY AS PER INCOME TAX BUT AS PER FINANCIAL RECORDS IT WILL BE SHOWN AS INCOME IN FUTURE YEARS WHICH WILL NOT BE TAXED IN INCOME TAX. SO THE DIFFERNCE IS FUTURE DEDUCTIBLE.
(D)	GOODWILL TO BE IMPAIRED IN BOOKS BUT TO BE AMORTISED IN INCOME TAX	0	22500		22500	THIS IS TEMPORARY DIFFERNCE BECAUSE WE WILL RECIVE THE TAX BENEFIT IN INCOME TAX IN CURRENT YEAR WHILE IN BOOKS WE WILL GET FUTURE BENEFITS OF TAX FROM IT. SO IT RESULTS IN FUTURE TAXABLE.
(E)	DEPRECIATION ON EQUIPMENT	20000	5579	14471	(14471)	THIS IS TEMPORARY DIFFERNCE. WE ALREADY GOT TAX BENEFITS IN PAST YEARS SO WE HAVE TO PAY TAX ON IT IN CURRENT YEAR
(F)	PENSION FUND BOOKED ON ACCURAL BASIS IN BOOKS AND ON PAYMENT BASIS IN TAX	42000	2000		(40000)	THIS IS TEMPORARY DIFFERNCE AS WE WILL GET TAX BENEFITS IN FUTURE AS AND WHEN WE WILL ACTUALLY PAY THE SAME.
	TOTAL			14471	(174451)
	DEDUCIBLE TO BE REVERSED				12000
	NET			14471	(162451)

S.NO.	PARTICULARS	BOOK AMOUNT	TAX AMOUNT	CURRENT TAXABLE (DEDCUCTIBLE) AMOUNT	FUTURE TAXABLE (DEDCUCTIBLE) AMOUNT	CLASSIFICATION
	OPENING BALNCE				(162451)
(A)	INTEREST INCOME EARNED ON EXEMPT MUNICIPAL BONDS	34000	0	0	0	THIS IS PERMANANT DIFFERNCE BECAUSE THIS INCOME WILL NEVER GET TAXED IN INCOME TAX AS THE INCOME EARNED IS EXEMPT.
(B)	FRANCHISEE INCOME RECEIVED IN 2018 BUT CHARGED IN BOOKS AS PER SERVICES RENDERED	4000	0	(4000)	4000	THIS IS TEMPORARY DIFFERNCE BECAUSE FRANCHISEE INCOME IS TAXED WHOLLY AS PER INCOME TAX BUT AS PER FINANCIAL RECORDS IT WILL BE SHOWN AS INCOME IN FUTURE YEARS WHICH WILL NOT BE TAXED IN INCOME TAX. WE SHOWN LAST YEAR 10000 AS FUTURE DEDCUTIBLE, NOW WE NEED TO REVERSE 4000 AS IT IS SHOWN AS INCOME IN FINANCIAL RECORDS
(C)	GOODWILL TO BE IMPAIRED IN BOOKS BUT TO BE AMORTISED IN INCOME TAX	45000	45000		0	NO DIFFERNCE
(D)	DEPRECIATION ON EQUIPMENT	20000	4666	15334	(15334)	THIS IS TEMPORARY DIFFERNCE. WE ALREADY GOT TAX BENEFITS IN PAST YEARS SO WE HAVE TO PAY TAX ON IT IN CURRENT YEAR
(E)	PENSION FUND BOOKED ON ACCURAL BASIS IN BOOKS AND ON PAYMENT BASIS IN TAX	50000	5000		(45000)	THIS IS TEMPORARY DIFFERNCE AS WE WILL GET TAX BENEFITS IN FUTURE AS AND WHEN WE WILL ACTUALLY PAY THE SAME.
	TOTAL			19534	(218785)
	DEDUCIBLE TO BE REVERSED				15000
	NET			19534	(213785)

	PRETAX FINANCIAL INCOME	180000	210000
	EXEPMT INCOME	(34000)	(34000)
	PENALTY FOR POLLUTION	100000	0
	FRANCHISEE INCOME	10000	(4000)
	GOODWILL AMORTISATION	(22500)	0
	DEPRECIATION	14471	15534
	PENSION EXPENSE	40000	45000
	TAXABLE INCOME	287971	232534

JOURNAL ENTRY FOR 2018

PROFIT & LOSS DR. 71993

TO PROVISION FOR TAX 71993

( BEING PROVIDION CREATED ON 287971*25%)

JOURNAL ENTRY FOR 2019

PROFIT & LOSS DR. 58134

TO PROVISION FOR TAX 58134

( BEING PROVIDION CREATED ON 232534*25%)