Question

At the end of its first year of operations on December 31, 2018, the Skyway Company reported taxable income of $30,000 and a pretax financial loss of $40,000. Differences between taxable income and pretax financial income included:Environmental fine from the EPA = $20,000Warranty costs expensed for accounting purposes in excess of cash paid for warranty costs = $50,000(Those warranty costs are expected to be paid in 2019.) The enacted tax rates for 2018 and 2019 are 30% and 34%, respectively.REQUIRED:(a) Prepare the income tax journal entry for the Skyway Company on December 31, 2018, assuming that it is more likely than not the deferred tax asset will be realized.(b) Prepare the income tax journal entry for the Skyway Company on December 31, 2018, assuming that it is more likely than not that 40% of the deferred tax asset will not be realized.

Answer 1

Case (a)

Entire deferred tax asset is realisable.

Current income tax = Taxable income × Tax rate for 2018 = $30,000 × 30% = $9,000

Deffered tax asset = Excess warranty expense recorded in books × Tax rate for 2019 × 100% realisation = $50,000 × 34% × 100% = $17,000

Journal

Date	Particulars	Debit	Credit
12/31/2018	Current tax expense	$9,000
	To Income tax payable		$9,000
	(To record income tax expense payable for current year)
12/31/2018	Deffered tax asset	$17,000
	To Deferred tax income		$17,000
	(To record deferred tax asset)
12/31/2018	Deferred tax income	$17,000
	To Current tax expense		$9,000
	To Income Summary		$8,000
	(To record transfer tax to income summary)

Case (b)

40% of deferred tax asset is not realisable.

Current income tax = Taxable income × Tax rate for 2018 = $30,000 × 30% = $9,000

Deffered tax asset = Excess warranty expense recorded in books × Tax rate for 2019 × 100% realisation = $50,000 × 34% × 60% = $10,200

Journal

Date	Particulars	Debit	Credit
12/31/2018	Current tax expense	$9,000
	To Income tax payable		$9,000
	(To record income tax expense payable for current year)
12/31/2018	Deffered tax asset	$10,200
	To Deferred tax income		$10,200
	(To record deferred tax asset)
12/31/2018	Deferred tax income	$10,200
	To Current tax expense		$9,000
	To Income Summary		$1,200
	(To record transfer tax to income summary)