Question

Integrating problem—bonds, leases, taxes

The long-term liabilities section of CPS Transportation’s December 31, 2015, balance sheet included the following:

a.  A lease liability with 15 remaining lease payments of $10,000 each, due annually on January 1:

Lease liability	$76,061
Less: Current portion	2,394
	$73,667

The incremental borrowing rate at the inception of the lease was 11% and the lessor’s implicit rate, which was known by CPS Transportation, was 10%.

b.  A deferred income tax liability due to a single temporary difference. The only difference between CPS Transportation’s taxable income and pretax accounting income is depreciation on a machine acquired on January 1, 2015, for $500,000. The machine’s estimated useful life is five years, with no salvage value. Depreciation is computed using the straight-line method for financial reporting purposes and the MACRS method for tax purposes. Depreciation expense for tax and financial reporting purposes for 2016 through 2019 is as follows:

Year	MACRS Depreciation	Straight-line Depreciation	Difference
2016	$160,000	$100,000	$60,000
2017	80,000	100,000	(20,000)
2018	70,000	100,000	(30,000)
2019	60,000	100,000	(40,000)

The enacted federal income tax rates are 35% for 2015 and 40% for 2016 through 2019. For the year ended December 31, 2016, CPS’s income before income taxes was $900,000.

On July 1, 2016, CPS Transportation issued $800,000 of 9% bonds. The bonds mature in 20 years and interest is payable each January 1 and July 1. The bonds were issued at a price to yield the investors 10%. CPS records interest at the effective interest rate.

Required:

1.  Determine CPS Transportation’s income tax expense and net income for the year ended December 31, 2016.

2.  Determine CPS Transportation’s interest expense for the year ended December 31, 2016.

3.  Prepare the long-term liabilities section of CPS Transportation’s December 31, 2016, balance sheet.

Answer 1