Question

Reproduced below are the journal entries related to Illustration 17–12 in this chapter that Global Communications used to record its pension expense and funding in 2021 and the new gain and loss that occurred that year. To focus on the core issues, we ignored the income tax effects of the pension amounts. 

 

Required: 

1. Recast these journal entries to include the income tax effects of the events being recorded. Assume that Global’s tax rate is 25%. [Costs are incurred and recognized for financial reporting purposes now, but the tax impact comes much later—when these amounts are deducted for tax purposes as actual payments for retiree benefits occur in the future. As a result, the tax effects are deferred, creating the need to record deferred tax assets and deferred tax liabilities. So, you may want to refer back to Chapter 16 to refresh your memory on these concepts.] 

2. Prepare a statement of comprehensive income for 2021, assuming Global’s only other sources of comprehensive income were net income of $300 million and a $30 million unrealized holding gain on investments in securities available for sale.

Answer 1

Pension Expense

This is one of the expenses to a company like wages and salaries which is paid for the employees for their services. Pension expense includes the following elements:

 

1. Service cost

2. Interest cost

3. Expected return on plan assets

4. Amortization of prior service cost

5. Amortization of net loss or net gain

 

Deferred Tax Asset

The amount of taxes that is paid or carried forward but not yet identified in the income statement is referred as deferred tax asset.

 

Deferred Tax Liability

Deferred tax liability arises due to timing (current and future) difference in the value of assets as per company’s account and as per income tax act.

 

(1)

Prepare journal entry to include income tax effects in pension expense and funding in 2020 and the new gain and loss.

 

Journal entry for pension expense: 

Date	Account title and Explanation	Debit ($)	Credit ($)
	Deferred Tax Asset	15,200,000
	Pension Expense	43,000,000
	Plan Assets (Expected Return)	27,000,000
	Projected Benefit Obligation		65,000,000
	Amortization of Prior Service Cost – Other comprehensive Income (OCI)		2,400,000
	Amortization of Net Loss- Other comprehensive Income (OCI)		600,000
	(To record the pension expense including taxes.)		17,200,000

 

Working notes:

Calculate the amount of deferred tax asset.

Deferred tax assets = (service cost + Internet cost-Expected return on plan assets) × Tax rate

                               = ($41,000,000 + $24,000,000 - $27,000,000) × 40%

                               = $15,200,000

 

Calculate the amount of amortization of prior service cost with tax effect.

Amortization of Prior service cost = [(Amortization of prior service cost before tax) –                           

                                                               (Amortization of prior service cost before tax × tax rate)]

 

Amortization of prior service cost = $4,000,000 – ($4,000,000 × 40%)

                                                             = 4,000,000 – $1,600,000

                                                             = $2,400,000

 

Calculate the amount of amortization of net loss with tax effect.

Amortization of net loss = [(Amortization of net loss before tax) –

                                             (Amortization of net loss before tax × tax rate)]

 

Amortization of Net loss = $1,000,000 – ($1,000,000 × 40%)

                                             = $1,000,000 - $400,000

                                             = $600,000

 

Calculate the amount of income tax expense.

Income tax expense = Pension expense × Tax rate

                                     = $43,000,000 × 40%

                                     = $17,200,000

 

Journal entry for funding and payment of obligation and its effect on income tax:

Date	Account Title and Explanation	Debit ($)	Credit ($)
	Plan Assets	48,000,000
	Cash		48,000,000
	(To record cash contribution to plan assets.)

 

Date	Account Title and Explanation	Debit ($)	Credit ($)
	Income tax payable	19,200,000
	Deferred Tax Asset		19,200,000
	(To record effect on tax due to cash distribution)

 

Note: When cash of $48,000,000 is paid, it is deducted for tax purposes. It reduces the temporary difference and thus reduces the deferred tax asset. As a portion of asset is realized, income tax payable is also reduced.

 

Working note:

Calculate the amount of income tax payable or deferred tax asset which is reduced due to payment.

 

Journal entry for new gains and losses:

Date	Account Title and Explanation	Debit ($)	Credit ($)
	Deferred Tax Asset	9,200,000
	Loss – OCI	13,800,000
	PBO		23,000,000
	(To record new losses.)

Date	Account Title and Explanation	Debit ($)	Credit ($)
	Plan Asset	3,000,000
	Gain – OCI		1,800,000
	Deferred Tax Liability		1,200,000
	(To record new gains.)

 

Working notes:

Calculate the amount of deferred tax asset.

Deferred tax asset = PBO × Tax rate

                                  = $23,000,000 × 40%

                                  = $9,200,000

 

Calculate the amount of deferred tax liability.

Deferred tax liabilities = Plant asset × Tax rate

                                        = $3,000,000 × 40%

                                        = $1,200,000

 

(2)

Prepare a statement of comprehensive income for 2020.

G communications Statement of Comprehensive Income Year ended December 31
Net income		$300,000,000
Other comprehensive income:
Net unrealized holding gain on investments	$18,000,000
Loss on pensions – PBO estimate	$(13,800,000)
Gain on pensions-return on plan assets	$1,800,000	$6,000,000
Comprehensive income		$306,000,000

 

Working note:

Calculate net unrealized holding gain on investment.

(Net unrealized holding gain on investment) = Unrealized holding gain on investment – Tax

                                                                               = $30,000,000 – ($30,000,000 × 40%)

                                                                               = $30,000,000 - $12,000,000

                                                                               = $18,000,000

(1) The amount of deferred tax liability is $1,200,000.

(2) Net unrealized holding gain on investment is $18,000,000.