Question

E19-20.  

(Two Differences, One Rate, First Year)

(LO 1, 2, 4) The differences between the book basis and tax basis of the assets and liabilities of Castle Corporation at the end of 2016 are presented below.

	Book Basis	Tax Basis
Accounts receivable	$50,000	$-0-
Litigation liability	?30,000	?-0-

It is estimated that the litigation liability will be settled in 2017. The difference in accounts receivable will result in taxable amounts of $30,000 in 2017 and $20,000 in 2018. The company has taxable income of $350,000 in 2016 and is expected to have taxable income in each of the following 2 years. Its enacted tax rate is 34% for all years. This is the company's first year of operations. The operating cycle of the business is 2 years.

Instructions

(a)  

Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2016.

(b)  

Indicate how deferred income taxes will be reported on the balance sheet at the end of 2016.

Answer 1

a) Calculation of Deferred Tax Asset and Deferred Tax Liability (Amounts in $)

Temporary Differences	Future Taxable (deductible) Amounts (A)	Tax Rate (B)	Deferred Tax Asset (A*B)	Deferred Tax Liability (A*B)
Accounts Receivable	50,000	34%	-	17,000
Litigation liability	(30,000)	34%	10,200	-
Totals			10,200	17,000

Income Tax Payable = Taxable Income*Tax Rate

= $350,000*34% = $119,000

Journal Entry (Amounts in $)

Account Titles and Explanation	Debit	Credit
Income Tax Expense ($17,000+$119,000-$10,200)	125,800
Deferred Tax Asset	10,200
Income Tax Payable		119,000
Deferred Tax Liability		17,000

b)

Temporary Differences	Resulting Deferred Tax (Asset)/Liability	Related Balance Sheet Account	Classification
Accounts Receivable	17,000	Accounts Receivable	Current
Litigation Liability	(10,200)	Lawsuit Obligation	Current

The deferred tax asset is current because the related liability is also current. The liability from the accrual of the litigation is current because it is expected to be settled in 2017 (i.e year immediately following the balance sheet date).

The deferred tax liability is current because the related asset accounts receivable is classified as a current asset. The entire accounts receivable balance is classified as current because the operating cycle of the business is 2 years.