Question

On January 1, 2017, Abbey acquires 90 percent of Benjamin's outstanding shares. Financial information for these two companies for the years of 2017 and 2018 follows:

2017 2018

Abbey Company:

Sales $ (684,000 ) $ (1,004,000 )

Operating expenses 462,000 516,000

Intra-entity gross profits in ending inventory (included in above figures) (213,000 ) (247,000 )

Dividend income—Benjamin Company (13,500 ) (31,500 )

Benjamin Company:

Sales (307,000 ) (361,000 )

Operating expenses 162,000 209,000

Dividends paid (15,000) (35,000 )

Assume that a tax rate of 40 percent is applicable to both companies. On consolidated financial statements for 2018, what are the income tax expense and the income tax currently payable if Abbey and Benjamin file a consolidated tax return as an affiliated group? On consolidated financial statements for 2018, what are the income tax expense and income tax currently payable if they choose to file separate returns?

Answer 1

1. if Abbey and Benjamin file a consolidated tax return as an affiliated group-

Consolidated Return - 2018

Abbey income 2018
Sales	$1,004,000
Less: operating Expenses	$516,000
Income	$488,000
Benjamin income 2018
Sales	$361,000
Less: operating Expenses	$209,000
Income	$152,000
Total (I + II)	$640,000
2017 deferred Intra-entity gross profits	$213,000
2018 deferred Intra-entity gross profits	($247,000)
Taxable Income	$606,000
Tax rate	40%
Income Tax currently payable	$242,400

Note: The intra-entity gross profit of 2018 is not taxed until it is realized. Dividend Income is not considered while filing a consolidated tax return.

2. Abbey and Benjamin choose to file separate returns-

Abbey income 2018
Sales	$1,004,000
Less: operating Expenses	$516,000
Income	$488,000
Tax rate	40%
Income Tax payable	$195,200

Note: The intra-entity gross profit of 2018 is not taxed until it is realized. The dividends would not be taxable because Benjamin still is a member of an affiliated group.

Income tax expense for Abbey-

Taxable income	$488,000
Intra-entity gain taxed in 2017 although realized in 2018	$213,000
Intra-entity gain taxed in 2018 although not yet realized	($247,000)
2018 realized income subject to taxation	$454,000
Tax rate	40%
Income Tax expense	$181,600

Income Tax expense = $181,600

Income Tax payable = $195,200

Difference = $13,600 is due to the tax effect on the net unrealized gain [($247,000 - $213,000) × 40%].

Benjamin income 2018
Sales	$361,000
Less: operating Expenses	$209,000
Income	$152,000
Tax rate	40%
Income Tax payable	$60,800

Benjamin will have tax expense and tax payable of $60,800