Question

On January 1, 2017, Abbey acquires 90 percent of Benjamin's outstanding shares. Financial information for these two companies for the years of 2017 and 2018 follows:

		2017			2018
Abbey Company:
Sales	$	(500,000	)	$	(700,000	)
Operating expenses		300,000			400,000
Intra-entity gross profits in ending inventory (included in above figures)		(120,000	)		(150,000	)
Dividend income—Benjamin Company		(18,000	)		(36,000	)
Benjamin Company:
Sales		(210,000	)		(270,000	)
Operating expenses		130,000			170,000
Dividends paid		(20,000	)		(40,000	)

Assume that a tax rate of 35 percent is applicable to both companies.

A. On consolidated financial statements for 2018, what are the income tax expense and the income tax currently payable if Abbey and Benjamin file a consolidated tax return as an affiliated group?

Income Tax Expense:

Income Tax Payable:

B. On consolidated financial statements for 2018, what are the income tax expense and income tax currently payable if they choose to file separate returns?

Income Tax Expense:

Income Tax Payable:

Answer 1

When filing returns as an affiliated group, Abbey and Benjamin will be taxed on their combined Operating Income,

The operating Income is given by Sales - Expenses

Dividends and Intra-entity gross profits don't matter when filing as an affiliated group.

For year 2017,

Operating Income of Abbey = Sales of Abbey - Expenses of Abbey = -$500,000 - $300,000 = -$800,000

The Operating Income of Benjamin = Sales of Benjamin - Expenses of Benjamin= -$210,000 - $130,000 = -$340,000

Combined Income of Abbey and Benjamin = -$800,000 + -$340,000 =-$1140,000

Tax rate = 35%

Tax payable = 35% of -$1140,000 = -$339,000

For year 2018,

Operating Income of Abbey = Sales of Abbey - Expenses of Abbey = -$700,000 - $400,000 = -$1100,000

Operating Income of Benjamin = Sales of Benjamin - Expenses of Benjamin= -$270,000 - $170,000 = -$440,000

Combined Income of Abbey and Benjamin = -$1100,000 + -$440,000 =-$1540,000

Tax rate = 35%

Tax payable = 35% of -$1540,000 - Tax refund from last year = -$539,000 - -$339,000 = -$200,000

Tax Expense = 0

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Even when taxes are filed separately, consolidated statement is presented by parent company (having over 80% rights).

Here we'll have to calculate taxes of both companies separately and combine them after which we need to adjust them for items reported on consolidated basis.

For year 2017,

Operating Income of Abbey = Sales of Abbey - Expenses of Abbey = -$500,000 - $300,000 = -$800,000

Operating Income of Benjamin = Sales of Benjamin - Expenses of Benjamin= -$210,000 - $130,000 = -$340,000

Combined Income of Abbey and Benjamin = -$800,000 + -$340,000 =-$1140, 000

Adjustment to combined income = -$1140, 000 + -$120,000 = -$1260, 000

Taxes for 2017 = 35% of -$1260, 000 = -$441,000

For year 2018,

The Operating Income of Abbey = Sales of Abbey - Expenses of Abbey = -$700,000 - $400,000 = -$1100,000

Operating Income of Benjamin = Sales of Benjamin - Expenses of Benjamin= -$270,000 - $170,000 = -$440,000

Combined Income of Abbey and Benjamin = -$800,000 + -$340,000 =-$1540,000

Adjustment to combined income = -$1540,000 + -$150,000 = -$1690,000

Taxes for 2018 = 35% of -$1690,000 - Tax refund from last year = -$591,500 - -$441,000 = -$150,500

Tax payable = -$150,500

Tax expense = 0