Question

Skywalker Manufacturing, a calendar-year corporation began operations in 1986. It is located in Shubuta, Mississippi. Many of its revenues and expenses are recognized in the same period for both GAAP and tax purposes. However, Skywalker uses different accounting methods for calculating net income and taxable income for depreciation, warranties, and operating leases. Skywalker uses straight-line depreciation and chooses the useful lives of assets for its financial income and uses tax deprecation and statutory asset lives for its taxable income. Skywalker provides warranties with most of its manufactured products, with the estimated warranty costs being expensed in the financial statements when the products are sold. The actual warranty costs are not deductible for tax purposes until they are paid. The last book-tax difference that Skywalker has routinely is prepaid lease expenses for operating leases, which are tax-deductible when paid. The operating lease amounts are expensed evenly over the life of each right-of-use asset. Skywalker is a mid-sized firm. In recent years, Skywalker has had a 35% marginal and effective corporate tax rate. At the beginning of 2017, Skywalker had the following cumulative differences between its taxable income and its book income and the resulting deferred tax assets/liabilities:

	Cumulative	Deferred Tax
	Difference	Asset/(Liability)
Excess tax depreciation	$5,700,000	($1,995,000)
Warranty expenses accrued but not paid	450,000	157,500
Prepaid operating lease costs	124,000	(43,400)

In early December of 2017, Jack Black, an employee in the Skywalker corporate finance and accounting office, began analyzing the temporary differences in preparation for the year-end financial statements. Jack also began determining what journal entry would be required at the end of the year with respect to deferred taxes. For 2017, the anticipated tax return and financial statement amounts for depreciation, warranties, and operating leases are as follows:

	GAAP	Tax
Depreciation	$6,500,000	$7,200,000
Warranties	730,000	675,000
Operating Leases	286,000	310,000

On December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law. It reduced the corporate tax rate to 21% for all years starting after 2017. The TCJA also changed the treatment of tax net operating losses (NOLs). Prior to the change, companies had two options with respect to an NOL: (1) carry it back two years and carry forward any unused amount for up to 20 years, or (2) carry the NOL forward for up to 20 years until used. The TCJA eliminated the carryback option and extended the carryforward option indefinitely but limited the carryforward offset each year to 80% of taxable income. CASE REQUIREMENTS

a. In early December, Jack asks for your help. Determine the anticipated deferred tax asset and liability account balances at the end of 2017. Show the anticipated journal entry for the year if Skywalker expects a taxable income of $25,000,000.

b. After the TCJA was signed on December 22, 2017, Jack asks you to again help by determining the anticipated deferred tax asset and liability account balances at the end of 2017. Show the new anticipated journal entry for the year if Skywalker expects a taxable income of $25,000,000.

c. Comment on the differences you calculated in the prior two requirements. What was the effect of the tax rate reduction for Skywalker? What would the effect have been for a company that has more deferred tax assets than liabilities at the end of 2017?

Answer 1

a. Schedule of Deferred Tax Assets and Liabilites at the end of December 2017
Particulars	GAAP	TAX	Deferred Tax Asset	Deferred Tax Liability
Depreciation	$                 65,00,000	$                 72,00,000		$                      -2,45,000
Warranties	$                    7,30,000	$                    6,75,000	$                       19,250
Operating Leases	$                    2,86,000	$                    3,10,000		$                            -8,400
Add: Opening balances				$                    -19,95,000
Depreciation			$                   1,57,500
Warranties				$                          -43,400
Operating Leases
Total			$                   1,76,750	$                    -22,91,800
If we net off both deferred tax and deferred tax liability there is deferred tax liability of
(2291800)+176750   =	$                -21,15,050
Journal Entry will be
Account Title	Debit	Credit
Deferred Expense	$                 21,15,050
Deferred tax liability		$                 21,15,050
b. After signing of TCJA there will be no impact on deferred tax asset and deferred tax liability amount because corporate tax rate has been reduced for all year after 2017 and we are doing calculation for ending 2017, so calculation will be same.
c. As discussed in above point b there is no difference in deferred tax after signing of TCJA, hence no effect of tax reduction for Skywalker
If company would have more deferred tax assets than liabilites then there will be deferred income that would be added to P& L and will be accounted under deferred income, so journal entry for such situation will be
Debit: Deferred tax assets
Credit: Deferred Income