Question

At the end of 2020, Payne Industries had a deferred tax asset account with a balance of $25 million attributable to a temporary book-tax difference of $100 million in a liability for estimated expenses. At the end of 2021, the temporary difference is $64 million. Payne has no other temporary differences and no valuation allowance for the deferred tax asset. Taxable income for 2021 is $180 million and the tax rate is 25%.

Required:
1. Prepare the journal entry(s) to record Payne’s income taxes for 2021, assuming it is more likely than not that the deferred tax asset will be realized.
2. Prepare the journal entry(s) to record Payne’s income taxes for 2021, assuming it is more likely than not that only one-fourth of the deferred tax asset ultimately will be realized.
  

Answer 1

1. Desired Ending balance of deferred tax asset = Temporary book tax difference * Tax rate = $64 million * 25% = $16 million

Beginning balance of deferred tax asset = Temporary difference in 2020 * Tax rate = $100 million * 25% = $25 million

Change in balance = Desired Ending balance of deferred tax asset - Beginning balance of deferred tax asset = $16 million - $25 million = ($9 million)

Income tax payable = Taxable Income * Tax rate = $180 million * 25% = $45 million

Income tax expense value = Income tax payable + Deferred tax asset value = $45 million + $9 million = $54 million

Journal entry to record Payne’s income taxes for 2021

Income tax expense Dr $54 million

To Deferred tax asset $9 million

To Income tax payable $45 million

(To record income taxes)

2. Valuation allowance = Desired Ending balance of deferred tax asset * 3/4 = $16 million * 3/4 = $12 million

Income tax expense = Income tax payable + Deferred tax asset value + Valuation allowance = $45 million + $9 million + $12 million = $66 million

Journal entry to record Payne’s income taxes for 2021, assuming it is more likely than not that only one-fourth of the deferred tax asset ultimately will be realized

Income tax expense Dr $66 million   

To Deferred tax asset $9 million

To Income tax payable $45 million

To Valuation Allowance $12 million

(To record income taxes)