Question

Farmer Inc. began business on January 1, 2019. Its pretax financial income for the first 2 years was as follows:

                              2019                                  $340,000

                              2020                                    760,000

The following items caused the only differences between pretax financial income and taxable income.

1.    In 2019, the company collected $420,000 of rent; of this amount, $140,000 was earned in 2019; the other $280,000 will be earned equally over the 2020–2021 periods. The full $420,000 was included in taxable income in 2019.

2.    The company pays $20,000 a year for life insurance on officers.

3.    In 2020, the company terminated a top executive and agreed to $90,000 of severance pay. The amount will be paid $30,000 per year for 2020–2022. The 2020 payment was made. The $90,000 was expensed in 2020 for financial reporting purposes. For tax purposes, the severance pay is deductible as it is paid.

4. The company purchased a large asset in 2019 for $60,000. The depreciation will be computed using a five-year life. For tax purposes, the company will be able to deduct half of the cost in 2019 and in 2020.

The enacted tax rates existing on December 31, 2019, are:

               2019                     30%                                      2021                     40%

               2020                     35%                                      2022                     40%

Instructions:

(a)      Determine taxable income for2019 and 2020.

(b)      Determine the deferred income taxes at the end of 2019, and prepare the journal entry to record income taxes for 2019.

(c)      Prepare a schedule of future taxable and (deductible) amounts at the end of2020.

(d)      Prepare a schedule of the deferred tax (asset) and liability at the end of2020.

(e) Compute the net deferred tax expense (benefit) for2020.

(f)       Prepare the journal entry to record income taxes for 2020.

Answer 1

a) Taxable incomes for 2019 and 2020:

Particulars	2019	2020
Pretax financial income	$340,000	760,000
Permanent differences: Life insurance	20,000	20,000
	360,000	780,000
Temporary differences:
rent	280,000	(140,000)
severance pay	-	60,000
Taxable income	640,000	700,000

b)i) deferred income taxes at the end of 2019

Particulars	2020	2021	Total
Future taxable (deductible ) amounts:
Rent (280,000/2)	(140,000)	(140,000)	(280,000)
Tax rates	35%	40%
Deferred tax (asset) liability	(49000)	(56000)	(105000)

Deferred income taxes at the end of 2019 is $105,000

b) ii) journal entry to record income taxes for 2019.

date	Account	Debit ($)	Credit ($)
	Income tax expense (192,000-105000)	87,000
	Deferred tax (asset)	105,000
	Income tax payable(640,000*30%)		192,000

c) schedule of future taxable and (deductible) amounts at the end of 2020.

Particulars	2021	2022	Total
Future taxable/deductible amounts:
Rent	(140,000)	(140,000)
Severance pay	(30,000)	(30,000)	(60,000)

d)schedule of the deferred tax (asset) and liability at the end of 2020.

Particulars	Amount (1)	Rate (2)	Deductible tax	Deferred tax (1)*(2)
Rent	140,000	40%	140,000	56000
Severance pays	60,000	40%	60,000	24000
TOTAL			200,000	80,000

(e)

Deferred tax asset at end of 2020     = $(80,000)

Deferred tax asset at beginning of 2020 =(105,000)

Net deferred tax expense (benefit) for 2020 = $(25,000)

f) journal entry to record income taxes for 2020.

date	Account	Debit ($)	Credit ($)
	Income tax expense (192,000-105000)	270,000
	Deferred tax (asset)		25,000
	Income tax payable(700,000*35%)		245,000