Question

1. On December 31, 2020, for GAAP purposes, Clubs Inc. reported a balance of $40,000 in a warranty liability for anticipated costs to satisfy future warranty claims. No claims were paid in 2020. Pretax GAAP income is $300,000 and the tax rate is 25%. Assume no other differences between the tax bases and GAAP bases of assets and liabilities, or any beginning balances in deferred tax accounts.

Required:

1. Record the income tax journal entry on December 31, 2020.

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b. Assume that there was a December 31, 2019, balance of $4,000 in the DTA account. Record the income tax journal entry on December 31, 2020.

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2. In 2020, Cardinals Company operated at a tax loss, totaling $88,000 during its first year of business. Assuming a tax rate of 25%, and that income is expected in 2021, record the entry to reflect the tax benefit of the net operating loss on December 31, 2020. Cardinals Company determined that it was more likely than not that 75% of the deferred tax asset would not be realized.

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Answer 1

Answer A.

We have to pay Income tax on $300,000+$40,000=$340,000 @ 25% and we will get benefits of warranty claims=$40,000 benefit in income tax when they actually incurred so Deferred Tax benefits is 25% of $40,000 = $10,000

Taxation 25% of $340,000 = $85,000

Accounting Entry:

Accounts	DEBIT	CREDIT
Profit and Loss Account	$ 75,000
Deferred Tax assets	$ 10,000
Income Tax payable		$ 85,000

Answer B.

DTA (Deferred Tax assets) has a opening balance of $4,000; If this balace is for other benefits which can be achieve in future tax benefits then accounting entry will be the same as given above. And if no other benefit will be arise from this $4,000 DTA then we will account remaining $6,000 in DTA and diffrence is charged to Proft and loss account. Accounting entry as under:

Accounts	DEBIT	CREDIT
Profit and Loss Account	$ 79,000
Deferred Tax assets	$ 6,000
Income Tax payable		$ 85,000

Answer C.

Future Tax benefits = 25% of $ 88,000 = $ 22,000

Entry to reflect the tax benefit:

Accounts	DEBIT	CREDIT
Deferred Tax assets	$ 22,000
Profit and Loss Account		$ 22,000

It is more more likely that 75% of DTA will not be realised it means we have to make provision against 75% of DTA which is $16,500.

Entry for make provision:

Accounts	DEBIT	CREDIT
Profit and Loss Account	$ 16,500
Provision for Deferred Tax assets		$ 16,500

  

Alternative Answer:

We can show Deferred Tax Assets; accounting entry by taking provision and in a signle entryn:

Accounts	DEBIT	CREDIT
Deferred Tax assets	$ 5,500
Profit and Loss Account		$ 5,500