Question

(TCO 1) Dale Co prepared the following items in its pretax financial income. Its financial income was $ 135,000.

Depreciation in excess of financials              22,000

Penalties paid to the IRS                                5,000

Warranty expenses on the financials              32,000

Warranty expenses paid                                  17,000

Interest on municipal bond                                2,5000

The rates for the current year are 32%, and all future years are 38%.

Determine the following:
1. Income tax payable

2. Which items are permanent and which are temporary

3. Determine the deferred tax asset and or liability

4. Prepare the journal entry for deferred taxes

Answer 1

1)

Financial Income	135000
Depreciation in excess of financials	(22000)
Penalties paid to the IRS   (disallowed)	5000
Warranty expenses on the financials	32000
Warranty expenses paid	(17000)
Interest on municipal bond	(25000)
Taxable Income	108000

Income tax payable : 108000*.32= $ 34560

2)

Depreciation in excess of financials	Temporary since at some point the depreciation will be higher under financials and lower income (reversed)
Penalties paid to the IRS	permanent as disallowed under tax
Warranty expenses on the financials	Temporary as under financial it is allowed on accrual basis
Warranty expenses paid	Temporary as under tax it is allowed on cash basis
Interest on municipal bond	permanent as disallowed under tax (tax free)

3)

Depreciation in excess of financials	Deferred tax liability as taxable income will be lower
Warranty expenses on the financials	Deferred tax asset (DTA)
Warranty expenses paid	Deferred tax liability (DTL)

Net effect :22000 DTL -32000 DTA +17000 DTL :

       = 7000 DTL (deferred tax liability)

4)

Date	Account	debit	credit
	Income tax expense	2660
	Deferred tax liability [7000*.38]		2660