Question

Online Storage Inc. reported pretax accounting income in 2018, 2019, and 2020 of $40 million, $70 million, and $75 million, respectively. The 2018 income statement does not include $15 million of revenue from cloud storage subscriptions received that year for one- and two-year subscriptions. The subscription revenue is reported for tax purposes in 2018. The revenue will be recognized in 2019 ($5 million) and 2020 ($10 million). The income tax rate is 20% each year. At the end of 2018, Management determines that it’s more likely than not that 1/3 of the deferred tax asset ultimately will not be realized. Required: Prepare a compound journal entry to record the income tax expense for the year 2018. Remember to account for any potential valuation allowance.

Answer 1

Journal entries required in Year 2018 -

Date	Particulars	Dr.	Cr.	Remarks
2018	Income tax expense A/c	$             8		20% of pre-tax income of year 2018
	To Income tax payable A/c		$             5	Refer Note 1
	To Deferred tax asset A/c		$             3	20% of pre-tax income of year 2018 less income tax payable of 2018 = {(20% of 40) - 5}
	(Being income tax and deferred tax of year 2018 recorded)
2018	Income Tax Expense A/c	$             1
	To valuation allowance - Deferred Tax assets A/c		$             1	(1/3rd of 3mn i.e. Deferred Tax asset)
	(Being non-realization of 1/3rd of deferred tax assets recorded)

Note 1 - Computation of Taxable income & Tax Payable

Particulars (Amount in $m)	Year 2018	Year 2019	Year 2020
Pretax accounting income	40	70	75
Income from from cloud storage subscriptions	-15	0	0
Collection of installment sales	0	5	10
Taxable Income	25	75	85
Income Tax Payable @20%	5	15	17