Question

Shannon Polymers uses straight-line depreciation for financial reporting purposes for equipment costing $680,000 and with an expected useful life of 4 years and no residual value. For tax purposes, the deduction is 40%, 30%, 20%, and 10% in those years. Pretax accounting income the first year the equipment was used was $780,000, which includes interest revenue of $19,000 from municipal bonds. Other than the two described, there are no differences between accounting income and taxable income. The enacted tax rate is 40%. Prepare the journal entry to record income taxes.

(If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

Answer 1

It should be noted that Accounting Income is $780,000 which includes a depreciation of $170,000 ($680,000 / 4) and an interest revenue of $19,000.

Computation of Taxable Income:

Accounting Income : $780,000

Add: depreciaiton (accounting): $170,000

Less: Interest revenue from Municipal bonds: $19,000

Less: depreciation (for Tax purposes): $272,000

Taxable Income: $659,000

Tax rate: 40%

Total tax provision: 263,600

It should also be noted that the depreciation difference between Accounting and Tax is a temporary difference and Interest revenue is permanent difference. For Temporary difference, Company need to create deferred tax asset/liability depending on event. In our answer, Shannon Polymers is claiming more depreciation in this year as compared to accounting depreciation. Hence a provision for deferred tax liability is to be created at the additional depreciation claimed.

Additional depreciation= $272,000 - $170,000 = $102,000

Deferred tax liability = $102,000 * 40% = $40,800

Accounting Entry will be as follows:

P & L A/c $304,400

To Provision for Income tax $263,600

To Deffered Tax Liability $40800

(Incometax provision created and deferred tax liability recorded)