Question

Begining of year 1

The firm purchased 30% of C Corp. for $700,000. At the time C. Corp. reported assets with a net book value of $2,000,000. The firm accounts for the securities using the equity method. The $100,000 excess of the implied fair value over book value is attributable to intangible assets that are amortized over 5 years.

Pre tax accounting income for year 1: $900,000

C corp income(100%) : $300,000

C corp dividend(100%): $120,000

Pre tax accoutning income for year 2: $1,200,000

C corp income (100%): $500,000

C corp dividend(100%): $140,000

Tax rate 30%.

Taxable income? Deferred tax liability? Deferred liability?

Answer 1

1. Taxable income
Year 1
Pretax accounting income	$900,000
Less: Amortization of intangible assets	($20,000)
Net Pretax accounting income	$880,000
Add: Equity income from C corp (30%)	$90,000
Taxable income	$970,000
Year 2
Pretax accounting income	$1,200,000
Less: Amortization of intangible assets	($20,000)
Net Pretax accounting income	$1,180,000
Add: Equity income from C corp (30%)	$150,000
Taxable income	$1,330,000
Under equity method, dividend received will be credited to equity investment
which will reduce the value of equity investment
2. Deferred tax liability
Amortization of intangible assets	$20,000
Tax @ 30%	$6,000
Deferred tax liability for year 1	$6,000
Amortization of intangible assets for 2 years	$40,000
Tax @ 30%	$12,000
Deferred tax liability for year 2	$12,000
3. Deferred liability
When C corp. stock is purchased, the difference between fair value of the assets and fair market value of
consideration paid is deferred.
Thus in this case, the difference of $100,000 is deferred liability.