Question

A16-8 Tax Calculations:

Penguin Corp. reported accounting earnings before taxes as follows: 20X6, $675,000; 20X7, $57,000. Taxable income for each year would have been the same as pre-tax accounting income except for the tax effects, arising for the first time in 20X6, of $7,200 in rent revenue, representing $1,200 per month rent revenue collected in advance on 1 October 20X6, for the six months ending 31 March 20X7. Rent revenue is taxable in the year collected. The tax rate for 20X6 and 20X7 is 25%, and the year-end for both accounting and tax purposes is 31 December. The rent revenue collected in advance is the only difference between accounting earnings and taxable income, and it is not repeated in October 20X7.

Required:

Is this a temporary difference? Why, or why not?

What is the accounting carrying value for the unearned rent at the end of 20X6? The tax basis? Explain.

Calculate taxable income and income tax payable, and prepare journal entries for each year-end.

Prepare a partial statement of profit and loss for each year, starting with pre-tax accounting earnings.

What amount of deferred income tax would be reported on the 20X6 and 20X7 statements of financial position?

Answer 1

Total rent income for six months ending March 20X7 = $1200*6 = $7200

Since the year-end for books of accounts is Dec 20X6 therefore, only 3 months of rental income between Oct 20X6 to Dec 20X6 will be accounted in books and balance will be unearned rental income to be accounted in next year. However, in tax accounting entire rental income including unearned rental income will be accounted to calculate the income tax.

Therefore, this will lead to a temporary difference in income as per accounts and as per tax and the income as per accounts and tax will be as follows for year 20X6 and 20X7 -

	20X6	20X7
Income as per accounting	$675000	$57000
unearned rental income from Jan 20X7 to Mar 20X7	$3600	($3600)
Income as per tax	$678600	$53400

Accounting carrying value for unearned rent for 20X6 will be for rent accruing in the period from Jan 20X7 to March 20X7 = $1200*3 = $3600 and the tax basis on such unearned rent income will be 3600*25% = $900

Taxable income as calculated in the above table will be $678600 in 20X6 and $53400 in 20X7 and income tax payable thereon will bee $169650 (678600*25%) in 20X6 and $13350 (53400*25%) in 20X7

Journal entries for 20X6 will be -

Bank A/c Dr. $7200
To Income A/c $3600
To Unearned rent income A/c $3600

Journal entries for 20X7 will be -

Unearned rent income A/c Dr. $3600
To Income A/c $3600

Deferred tax asset to be reported in the year 20X6 will be $3600*25% = $900

Such deferred tax asset will get reversed in 20X7 and thus the balance of deferred tax asset will be $0 in 20X7