Question

Question 3 Accounting for Income Taxes                                                   

Reed Ltd is a manufacturer of surfboards which commenced operations on 1 July 2019. The Statement of Comprehensive Income and the Statement of Financial Position were compiled on 30 June 2020. The following information was available:

Statement of Comprehensive Income for the year ended 30 June 2020

  $                      $

Sales			430,000
Less
Cost of Goods Sold		130,000
Administrative expense		70,000
Warranty expense		60,000
Depreciation- machine		40,000
Insurance expense		20,000	320,000
Profit before income tax			110,000

Following information was extracted from the Statement of Financial Position at 30 June 2020:

	2019	2020
Prepaid insurance	24,000	36,000
Machine	400,000	400,000
Less: Accumulated depreciation	40,000	80,000
Provision for warranty	34,000	28,000

Other information was available for the year ended 30 June 2020:

1. Sales are recorded for income tax purpose at the time the sales are made.
2. Cost of Goods Sold and administrative expense incurred have been paid. They are allowed as a tax deduction at the year end.
3. Warranty expense was accrued. Deduction for income tax purpose is available only when the amount is paid.
4. The machine was purchased two years ago at a value of $400,000. It is depreciated evenly over its useful life and it has no residual value. The useful life is ten years based on accounting policy, but it is depreciated over eight years according to the taxation rule.
5. Insurance is allowed as a tax deduction when it is paid.
6. Income tax rate is 30%.

Required: (Narrations are not required in this question)

1. Determine the amount of taxable income for the year ended 30 June 2020.
2. Determine the amount of income tax expense for the year ended 30 June 2020.
3. Prepare a journal entry to record current tax liability on 30 June 2020.
4. Determine the amount of tax base for machine.
5. Determine the amount of temporary difference for machine.
6. The temporary difference for machine is deductible in this question, is this correct? Explain.
7. Provide journal entry to record DTA or DTL for machine.

Answer 1

1. Taxable income is $ 82,000.

2. Income tax expense is $ 32,000.

3. Journal entry to record current tax liability is

Income tax expense Dr. 24,600

To Provision for income tax 24,600

4. Tax base of machine is $ 3,00,000.

5. Temporary difference is $ 20,000.

6. There is taxable temporary difference and therefore, DTL has to be recognised.

7. DTL journal entry is

Deferred tax expense Dr. 6000

To Deferred tax liability 6000

Detailed Workings for the above have been attached herewith.