Question

Arnold Industries has pretax accounting income of $32 million for the year ended December 31, 2021. The tax rate is 25%. The only difference between accounting income and taxable income relates to an operating lease in which Arnold is the lessee. The inception of the lease was December 28, 2021. An $8 million advance rent payment at the inception of the lease is tax-deductible in 2021 but, for financial reporting purposes, represents prepaid rent expense to be recognized equally over the four-year lease term.

Required:
1. Determine the amounts necessary to record Arnold’ income taxes for 2021, and prepare the appropriate journal entry.

2. Determine the amounts necessary to record Arnold’s income taxes for 2022, and prepare the appropriate journal entry. Pretax accounting income was $50 million for the year ended December 31, 2022.
3. Assume a new tax law is enacted in 2022 that causes the tax rate to change from 25% to 15% beginning in 2023. Determine the amounts necessary to record Arnold’s income taxes for 2022, and prepare the appropriate journal entry.

4. Why is Arnold’s 2022 income tax expense different when the tax rate change occurs from what it would be without the change?

Answer 1

Solution ::

step: 1 of 21

Taxable Income

Taxable income: The amount of adjusted gross income that is liable to be taxed is referred to as taxable income.

step: 2 of 21

(1)

Compute the income tax expense for A Industries and journalize the income tax transaction for 2018.

Step 1: Compute taxable income and income tax payable for 2018.

step: 3 of 21

Step 2: Compute deferred tax liability amount.

step: 4 of 21

Step 3: Compute income tax expense amount.

Note: Refer to Steps 1 and 2 for the values and computations of income tax payable value and deferred tax liability value.

step: 5 of 21

Step 4: Journalize the income taxes transaction.

Accounting equation: The following is the accounting equation for the income taxes:

step: 6 of 21

Journal entry: Record the following entry in the books of A Industries:

step: 7 of 21

Explanation:

• Income Tax Expense is an expense account. Expenses decrease the value of shareholders’ equity account. Therefore, debit Income Tax Expense account with $13,200,000.

• Deferred Tax Liability is a liability account. Since the liability amount increased, therefore, credit Deferred Tax Liability account with $3,200,000.

• Income Tax Payable is a liability account. The amount has increased because the taxable income has increased. Therefore, credit Income Tax Payable account with $10,000,000.

step: 8 of 21

(2)

Compute the income tax expense for A Industries and journalize the income tax transaction for 2019.

Step 1: Compute taxable income and income tax payable for 2019.

step: 9 of 21

step: 10 of 21

Step 2: Compute deferred tax liability amount.

Note: Refer to step 1 of requirement 1 for value and computation of beginning balance of deferred tax liability.

step: 11 of 21

Step 3: Compute income tax expense amount.

Note: Refer to Steps 1 and 2 of requirement 2 for the values and computations of income tax payable value and deferred tax liability value.

step: 12 of 21

Step 4: Journalize the income taxes transaction.

Accounting equation: The following is the accounting equation for the income taxes:

step: 13 of 21

Journal entry: Record the following entry in the books of A Industries:

step: 14 of 21

Explanation:

• Income Tax Expense is an expense account. Expenses decrease the value of shareholders’ equity account. Therefore, debit Income Tax Expense account with $20,000,000.

• Deferred Tax Liability is a liability account. Since the liability amount increased, therefore, credit Deferred Tax Liability account with $800,000.

• Income Tax Payable is a liability account. The amount has increased because the taxable income has increased. Therefore, credit Income Tax Payable account with $20,800,000.

step: 15 of 21

(3)

Compute the income tax expense for A Industries and journalize the income tax transaction for 2019, if new tax rate of 30% is enacted in 2020.

Step 1: Compute taxable income and income tax payable for 2019.

step: 16 of 21

Step 2: Compute deferred tax liability amount.

Note: Refer to step 1 of requirement 1 for value and computation of beginning balance of deferred tax liability.

step: 17 of 21

Step 3: Compute income tax expense amount.

Note: Refer to Steps 1 and 2 of requirement 2 for the values and computations of income tax payable value and deferred tax liability value.

step: 18 of 21

Step 4: Journalize the income taxes transaction.

Accounting equation: The following is the accounting equation for the income taxes:

step: 19 of 21

Journal entry: Record the following entry in the books of A Industries:

step: 20 of 21

Explanation:

â Income Tax Expense is an expense account. Expenses decrease the value of shareholders’ equity account. Therefore, debit Income Tax Expense account with $19,400,000.

Deferred Tax Liability is a liability account. Since the liability amount increased, therefore, credit Deferred Tax Liability account with $1,400,000.

Income Tax Payable is a liability account. The amount has increased because the taxable income has increased. Therefore, credit Income Tax Payable account with $20,800,000.

step: 21 of 21

(4)

Explanation:

The tax expense without change was $20,000,000 in 2019 (Refer to requirement 2).

The tax expense after the change was $19,400,000 in 2019 (Refer to requirement 2).

The tax on future taxable amount of $6,000,000 in 2019 requires to be adjusted to $600,000.

This change is reflected in the income tax expense of 2019 after the change $19,400,000 .