Question

tanhope, Inc.

Reconciliation of Pretax Accounting Income

to Taxable Income

Year ended December 31, year 2

Pretax accounting income

$678,000

Expenses recorded on books this year not deductible for tax purposes:

Meals and entertainment expenses

12,000

Bad debts expense provision

15,000

27,000

Subtotal

705,000

Income recorded on books this year not subject to tax:

Tax-exempt interest income

15,000

Unrealized gain (loss) on trading securities

8,000

Deductions on tax return not charged against book income this year:

Depreciation expense

63,000

Bad debts written off and charged against allowance account

5,000

91,000

Taxable income

$614,000

Reconciliation

Stanhope, Inc., a C corporation, is a distributor of personal electronics and has reported a net income for each year since inception. Its taxable income has consistently resulted in an effective tax rate of 33%. (Ignore state income taxes.)

You have been assigned to compute the company’s deferred portion of federal income taxes for inclusion in its financial statements for year 2 and to provide the company’s controller with a schedule that supports your computation. Your schedule should identify deductible and taxable temporary differences and components of the deferred tax computations.

The controller has provided you with the accompanying reconciliation (see Reconciliation tab) of Stanhope’s pretax accounting income to taxable income for year 2 and the additional information shown below. Use this information to answer the subsequent questions.

The Allowance for doubtful accounts (bad debts) as of December 31, year 1, was $11,000. During year 2, uncollectible accounts totaling $5,000 were written off and charged against the allowance account. A provision for bad debts of $15,000 was charged to operations at the end of the year to result in an Allowance for doubtful accounts balance at December 31, year 2, of $21,000.

At the end of the year, there were net unrealized gains on trading securities of $8,000. There were no unrealized gains/losses on trading securities at the beginning of the year.

The company uses straight-line depreciation for financial reporting (GAAP) purposes and accelerated methods for income tax purposes. Balances and activity in the accumulated depreciation account for GAAP and income tax purposes are summarized below:

	GAAP	Tax	Difference
Accumulated depreciation, December 31, year 1	1,314,000	2,018,000	704,000
Year 2 depreciation expense	196,000	259,000	63,000
Accumulated depreciation, December 31, year 2	1,510,000	2,277,000	767,000

Prepare the deferred tax computations and supporting components by completing the following worksheet.

In column A, double-click a shaded space and select a line item that will result in a temporary difference.

In column B, enter the total temporary difference that would result in a deferred tax asset or liability.

Enter the total deferred tax asset or liability in the appropriate column, C or D, based on the temporary difference you recorded in column B.

	A	B	C	D
1	Description of temporary differences	Temporary differences	Deferred tax assets	Deferred tax liabilities
2
3
4
5
6
7
8
9	Totals	$0	$0	$0

Answer 1

The Allowance for doubtful accounts (bad debts) is a temporary difference in that for financial reporting an allowance method is used to record bad debts expense for the year whereas for income tax purposes a direct write off method is used. The amount of the temporary difference is $21,000; the $11,000 starting balance less $5,000 actually written off plus the additional $15,000 charged. This results in a deferred tax asset of $6,930, $21,000 x 33% (the enacted tax rate), because this amount is expected to be written off for income tax purposes in future years,

The Accumulated depreciation, excess of tax over GAAP is a temporary difference in that for financial reporting the straight-line depreciation rate is used and for income tax purposes accelerated methods are used. The amount of the temporary difference is $767,000 (the amount provided as the difference at December 31, year 2). This results in a deferred tax liability of $253,110, the $767,000 x 33% (the enacted tax rate), because more income will be taxable in future years.