Question

Problem Five

Please prepare accounting entries or answer the questions asked for the following independent situations:

1. Diamond Company owns 40% of the stock of Silver Company. On January 1, 2019, Silver reports total income of $4,000,000. On June 1, 2019, Silver pays total dividends to its shareholders of $1,000,000. Prepare the necessary accounting entries for Diamond.

2. May Company purchased a bond issued by August Company on September 1, 2019 for $1,000,000. The bond is properly classified as Trading. On December 31, 2019, the market price of the bond is $1,100,000. Prepare the appropriate adjusting entry for May Company.

3. Strong Company has a temporary difference of $5,000,000 that properly gives rise to a deferred tax liability. The tax rate is 30%. Accordingly, Strong records a DTL of $1,500,000 on its books. What would the result be if Congress were to lower the tax rate to 20% assuming the temporary difference still exists.

4. Briefly distinguish a contract asset from a contract liability.

Answer 1

Solution:

1. Dividend Income

2. Bond Investment

3. Deferred Tax Liability

When due to temporary difference, the income tax payable is less than income tax expense recognised in financial statements then difference will be recorded as Deferred Tax Liability.

In this case, temporary difference is $ 50,00,000 and deferred tax liability of $ 15,00,000 is being created.

Deferred Tax Liability = Temporary difference x Tax Rate

= $ 50,00,000 x 30%

= $ 15,00,000

When, congress changes tax rate to 20% hence deferred tax liability will be $ 10,00,000 ($ 50,00,000 x 20%)

Here,again temporary difference exist and deferred tax liability will be created and will be recorded in deferred tax liability ledger. Hence ending balance of Deferred Tax Liability ledger will be = Beginning balance + Creation = $ 15,00,000 + $ 10,00,000 = $ 25,00,000.

4. Difference between Contract Asset and Contract Liability

Contract Asset

When any entity entered into contract to transfer any goods or service to customer then entity gains a right to receive payment from customer subject to certain conditions like completion of certain percentage of work etc. then such conditional right will be called as Contract Asset. Ex. When entity do provide construction services to customer and in agreement it is mentioned that payment will be due if certain percentage of work completed. Then only we can recognize revenue and generate bill to customer.

Contract Liability

Similar to contract asset when entity entered into contract to transfer any goods or service to customer but due to certain transactions entity recognized liability then such liability will be called as Contract Liability. Transactions may be like advance received from customer and entity’s performance is due. Contract liability is a part of contract asset but in negative terms. Or we can say that negative balance of contract asset account is contract liability.