Question

Bernie food wholesalers sells toys to retailers for credit(on account) As is true for all firms with receivables, some of Bernie clients default on their accounts. Hence there are bad debts. Following the matching principle,Bernie uses the allowance method and expenses estimated bad debts in the year for sale for financial reporting purposes. Folowing tax laws, on the tax return, Bernie uses the Direct write off method and deducts bad debt cost in the year an account is written off. In 2019, Bernies’ first year of operation Bernie recognized $170,000 of bad debt expense for financial accounting purposes(all from sales that occurred on December 21, 2019) Actual account defaults, and hence write offs, were for $64,000 in 2020 and $106,000 in 2021. No credit sales took place after 2019.

Other financial income , before considering bad debt expense was $655,000 per year. The tax rate was 30% all years.

Does the temporary difference arise from an underlying asset or an underlying liability? What is the name of this account? Is it on the financial books or , the tax records or both? What is income Tax payable for 2019, 2020,2021?

Answer 1

Allowance for Bad-debts is a temperory Difference. Diffrence is created in 2019 when provion was created. As per Tax Laws actual Bad-debts expenses is allowed not Allowance for Bad-debts. An underlying liability for allowance on Bad-debts created by $170,000.

So Deferred Tax Liability is created on this account and amount of DTL is = Bad-debts Provision *30%

= 170,000 * 30% = $51,000 (Deferred Tax Liability)

When actual bad-debts incurred than DTL will be adjusted against tax expense.

It is on Financial records.

Income Tax Payable:

Year	2019	2020	2021
Income Before Bad-debts	655,000	655,000	655,000
Bad-debts		64,000	106,000
Income after Bad-bets	655,000	591,000	549,000
Income Tax Rate	30%	30%	30%
Income Tax Payable	196,500	177,300	164,700