Question

Buck Co. has a deferred income tax liability in the amount of $192,000 at 31 December 20X7, relating to a $600,000 receivable. This sale was recorded for accounting purposes in 20X7 but is not taxable until the cash is collected. In 20X8, $400,000 is collected. Warranty expense in 20X8 included in the determination of pre-tax accounting income is $165,000, with the entire amount expected to be spent and deductible for tax purpose in 20X9. Pre-tax accounting earnings are $735,000 in 20X8. The tax rate is 28% in 20X8.

Required:

1. What is the tax rate in 20X7?
2. What is the accounting carrying value and the tax basis of both the account receivable and the warranty liability, at the end of 20X7 and 20X8?
3. Calculate taxable income and income tax payable, compute the balance in the deferred income tax accounts, and prepare the tax journal entry for year-end 20X8.
4. Of the deferred tax adjustment recorded in requirement 2, how much is caused by the change in the tax rate and how much is caused by new temporary differences?
5. Calculate the deferred income tax that would be reported on the statement of financial position at the end of 20X8.

Answer 1

1. Tax rate in 2017

Receivable on Dec 31, 2017 = $ 600,000

Deferred income tax liability pertaining to the above receivable = $192,000

Therefore, tax rate in 2017          = Deferred income tax liability / concerned receivable

                                                                = 192000/600000

                                                                = 32%

2. Carrying value and Tax basis for 2017 and 2018

a. At the end of 2017

	Carrying value	Tax basis
Account receivable	600000	0
Warranty expense	0	0

b. At the end of 2018

	Carrying value	Tax basis
Account receivable	200000	0
Warranty expense	165000	0

3. For the year 2018

Taxable income and income tax payable

	Analysis	Amount($)
Pre tax accounting income (where warranty exp included)	Given	735000
Add: Warranty expense	Since it is expected to be spent and deductible for tax purpose in 2019	165000
Add: Cash collected from receivable	Since the sale is Taxable in the year of collection	400000
Taxable income		13,00,000
Income tax rate	28%
Income tax payable	1300000*28%	3,64,000

Deferred tax account balances

	Calculation	Amount($)
Deferred tax liability at the end of 2017	Given	$192000
Deferred tax liability at the end of 2018	200000*28%	$56000
Deferred tax asset at the end of 2018	165000*28%	$46200
Net Deferred tax liability at the end of 2018	56000-46200	$9800

Journal entry for 2018

	Debit	Credit
Income tax expense a/c Dr	364000
To Provision for tax		364000
Deferred tax asset a/c Dr	46200
To Deferred tax income		46200
Deferred tax liability a/c Dr	136000
To Deferred tax income		136000

Net differed tax adjustment is 192000 – 9800 = 182200

4. Change due to tax rate change and new temporary differences

Due to tax rate change = 600000 *(32-28)% = 24000

Due to change in new temporary differences = 136000-24000 = 112000

5. Deferred income tax that would be reported in the statement of financial position at the end of 2018 is $9800(as calculated in point 3.