Question

Checkers Corporation

Checkers Corporation had a tax liability for 20X7 of $20,000 based on a tax rate of 40%, but the accounting staff needs your help in determining the tax expense and deferred tax amounts for 20X7. The enacted tax rates for the future periods are 35% for 20X8 – 20Y2, and then 30% for 20Y3 – 20Y6. Checkers does not believe that temporary differences can be reasonably projected beyond those periods. The taxable income for 20X8 was $100,000. Checkers also owned a 30% interest in Chess, which reported income of $50,000 and $60,000 in 20X7 and 20X8, respectively. Checkers received dividends of $5,000 and $8,000 from Chess for 20X7 and 20X8, respectively. Checkers expects this pattern of earnings and dividends to continue over the next ten years, if not longer.

Checkers estimated warranty expense to be $7,500 in 20X7 and $10,000 in 20X8. Actual warranty cost for the two years was $6,000 and $12,000, respectively. The bad debts expense recognized on the income statement was $15,000 in 20X7 and $20,000 in 20X8. Actual bad debt write-offs per the tax return were $10,000 in 20X7 and $15,000 in 20X8.

On January 1, 20X8 Checkers also received $30,000 of rent in advance covering a two-year rental agreement, and $5,000 for interest income on municipal bonds (classified as held-to-maturity securities). The bonds mature in 20Y0.

Depreciation expense calculations for Checkers are as follows:

Year Cost Recovery Depreciation Year Cost Recovery Depreciation 20X7 $24,000 $10,000 20Y2 9,000 10,000 20X8 24,000 10,000 20Y3 8,500 10,000 20X9 17,000 10,000 20Y4 4,500 10,000 20Y0 12,000 10,000 20Y5 ---- 10,000 20Y1 9,000 10,000 20Y6 ---- 10,000 (amounts continue in next columns) Totals $ 108,000 $ 100,000

Key Terminology

Taxable Income: Income (per IRC) less deductions (per IRC) per tax return Tax Liability: Taxes owed to government per income tax return (based on Taxable Income) Net Income: Revenue minus expenses per GAAP Provision for Income Taxes or Income Tax Expense: An income statement amount determined based upon the taxable/deductible GAAP components. Includes the amount currently payable per tax return (tax liability) plus/minus any deferred amounts computed per schedules. Deferred Income Taxes: A theoretical/conceptual liability that will be paid, only if the entity continues to generate a profit

into the future continues as a going concern. Deferred taxes are not a legal obligation.

Required:

1. Determine the tax expense and the deferred tax amounts for 20X7 and 20X8. 2. Determine the tax liability amount for 20X8. 3. Prepare all necessary journal entries for the two year period (20X7 – 20X8). 4. Prepare a partial income statement for 20X7 showing earnings before tax, provision for income tax, and net income. A good example of this format would be schedule M-1 from a corporate income tax return.

Answer 1

Checkers
		2017	2018
Taxable Income		80000	100000
Increase in awrranty ( Expenditure)		-1500
Decrease in warranty			2000
Increase in Bad debts		-5000	-5000
Reduction in depreciation		14000	14000
Profit as per Income Statement		87500	111000

Tax Expense Rate 40% 35%

Tax Expense as per books		35000	38850
Increase in Deffered Tax Liability		2600	1050
Decrease in Deffered Tax Liability		-5600	-4900

Workings::

Reduction in warranty		1500	-2000
Tax Rate		40%	35%
Increase in Deffered Tax Liability		600
Decrease in Deffered Tax Liability			-700

Reduction in bad debts against provisioning		5000	5000
Tax Rate		40%	35%
Decrease in Deffered Tax Liability		2000	1750

Depreciation:

	Tax	Book
Year	Cost Recovery	Depreciation	Difference
2017	24000	10000	14000
2018	24000	10000	14000
2019	17000	10000	7000
2020	12000	10000	2000
2021	9000	10000	-1000
2022	9000	10000	-1000
2023	8500	10000	-1500
2024	4500	10000	-5500
2025		10000	-10000
2026		10000	-10000

Deffered Tax Liability on Depreciation

-5600 (14000*.40)

-4900 (14000*.35)

3.Tax Expense Deffered A/c Dr 2600

To Deferred Tax Liability Ac cr 2600

Deferred Tax Liability A/c 5600

To Deffered Tax Liability 5600

For 2018 :

Tax Expense Deffered A/c Dr 1050

To Deferred Tax Liability Ac cr 1050

Deferred Tax Liability A/c 4900

To Deffered Tax Liability 4900

4. PArtial Income Statement :

Earnings before Tax: 87500

Provision for Tax 35000

Net Income : 52500