Question

In 2017, a company purchased a machine for $70,000; it has a three-year life for both accounting and tax. Depreciation for accounting (already included in pretax financial income) and tax purposes is shown below. Statutory tax rate is 30%. Record the required tax entries for each year.

              Accounting Tax               Difference

2017             30,000                 45,000                 15,000         

2018             20,000                 15,000                 (5,000)

2019             20,000                 10,000                 (10,000)

Pretax Financial Income

2017      $50,000

2018      60,000

2019      70,000

I have solution, but I don't know how to get each steps. please explain with T-accounts.

Answer 1

Deferred tax assets/Deferred tax liabilities:-

The tax effect on the timing differences is termed as deferred tax which literally means taxes which are deferred. Deferred tax is recognised on all timing difference – Temporary and Permanent.

These deferred taxes are given effect to in the financial statements through Deferred Tax Asset and Liability as under:

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)

Here, in the year 2017, income for tax purpose is less than book. so, deferred tax liability is created for $4,500 (15,000 * 30%)

In year 2018, income for tax purpose is more than book, so deferred tax asset is created for $1,500 (5000 * 30%)

In year 2019, income for tax purpose is more than book, so deferred tax asset created for $3,000 (10000 * 30%)

Tax Expense for the year 2017,

Pre tax financial income + Book depreciation - Tax depreciation

= 50,000 + 30,000 - 45,000

= 35,000

= $10,500 (35,000 * 30%)

Tax Expense for the year 2018,

= 60,000 + 20,000 - 15,000

= 65,000

= $19,500 (65,000 * 30%)

Tax Expense for the year 2019,

= 70,000 + 20,000 - 10,000

= 80,000

= $24,000 (80,000 * 30%)