Question

For the year ended Dec 31, 2020, King Inc. reported pretax accounting income of $800,000. Select information is listed below:

In 2020, the company started issuing stock options to its employees. The compensation expense related to stock options was $80,000. The compensation expense related to stock options is not deductible for tax purpose until the employees exercise the options in the future.

2) In 2020, the company purchased a piece of equipment with a cost of $500,000. For financial reporting purposes, the company used the straight-line method over a 5-year service life with no residual value expected. For tax purposes, the equipment was scheduled to be depreciated by $160,000, $140,000, $120,000, $50,000 and $30,000 in years 2020 through 2024, respectively.

3) During 2020 loss contingency accrued for financial reporting purpose was $45,000. The loss contingency was due to the pending patent lawsuit brought by its long-time competitor, Queen Inc. The payment for the lawsuit is expected to be paid in 2022.

4) In 2020, the company incurred $10,000 from municipal bonds. The interest earned on municipal bonds are exempted for tax purposes.

King Inc.’s income tax rate is 20%. At January 1, 2020, the deferred tax asset balance was $40,000 and the deferred tax liability was $5,000.

Required:

a) What is taxable income for 2020?

b) What s the ending balance of DTL on 12/31/2020?

c) What is the ending balance of DTA on 12/31/2020?

d) Prepare journal entries to record income taxes in 2020

e) Prepare 2020 income statement, beginning with"Income before income taxes". You need to reconcile current income tax expense with total income tax expense in this section.

Answer 1

a)Taxable income for the year 2020(in $)

Pretax accounting income		800000
Add:compensation expense		80,000
Add: book depreciation(500000/5)		100000
Less "Income tax dep		-160000
Add: Loss contingency		45000
Less:Interest on bonds		-10000
Taxable income		855000
Tax		171000
Accounting income		800000
Taxable income		855000
Timing difference		55000
Deffered Tax Assets		11000

Sl.No	Entity Profit Status	Entity – Current	Entity – Future	Effect
1	Book profit higher than the Taxable profit	Pay less tax now	Pay more tax in future	Creates Deferred Tax Liability (DTL)
2	Book profit is less than the Taxable profit	Pay more tax now	Pay less tax in future	Creates Deferred Tax Asset (DTA)

b)Ending balance of DTL on 12/31/2020 will be same as $5000.

c)Ending balance of DTA on 12/31/2020 will be $51000.i.e. (40000+ 110000)

d)Journal entries

For income tax

Profit and loss A/c Dr 171000

To Income tax A/c Cr 171000

For recording deferred tax

Deferred tax asset A/c Dr 11000

To Deferred tax expenses A/c cr 11000

e) Income statement 2020

Income before tax	$800000
Less:Income Tax	$171000
Less:Deferred tax	$11000
Income after tax	$618000