Question

Ashley Company began operations in 2020. Ashley’s pretax financial income for 2020 was $450,000. The tax law in 2020 says that the tax rate in 2020 is 25%, but it will be 20% in 2021 and in future years. Ashley’s pretax financial income for 2020 contained the following items that are treated differently for financial purposes than they are for tax purposes: Differences Amount included in Pretax Financial Income Amount included in Taxable Income Difference1 1. Interest earned on State of Ohio Bonds. (Note: Interest on these bonds is exempt from Federal Income Tax.) $ 9,000 $ 0 $ 9,000 2. Gross profit on installment sales. 300,000 200,000 100,000 3. Warranty expense. 19,600 13,600 6,000 4. Depreciation on machinery. 20,000 200,000 180,000

1 Note: Each difference shown above is shown as an absolute value. Therefore, that number contains no information about whether that difference should be added or subtracted in preparing the reconciliation of pretax financial income to taxable income. You are responsible for deciding how each difference should be treated.

Instructions:

A. Prepare a reconciliation of pretax financial income to taxable income for Ashley Company for 2020.

B. Compute Ashley’s Income Tax Payable as of the end of 2020.

C Compute the year-end balances in any deferred income tax asset and/or deferred income tax liability accounts that exist as of the end of 2020.

D. Compute Ashley’s Income Tax Expense for 2020.

Answer 1

Part A

Pretax accounting income (As per given)	450,000
Less: Interest income on municipal bonds	(9,000)
Pretax accounting income adjusted with Permanent difference	441,000
Less: excess gross profit on installment sales in books [Deferred tax liability]	(100,000)
Add: excess warranty expense in book [Deferred tax assets]	6,000
Less: Lower recorded depreciation expense in books [Deferred tax liability]	(180,000)
Taxable Income	167,000

Part B

Taxable Income	167,000
Multiply: Tax rate in 2020	25%
Income Tax Payable	41,750

Part C

Higher recorded warranty expense in books	6,000
Deferred tax asset (6000*20%)	1,200
Excess gross profit on installment sales in books	100,000
Lower recorded depreciation expense in books	180,000
Total	280,000
Deferred tax liability (280000*20%)	56,000

Part D

	Income Tax Expense for 2020	96,550
Date	Account title and explanation	Debit	Credit
Dec 31, 2020	Income Tax Expense [balancing figure]	96,550
	Deferred Tax Assets	1,200
	Deferred Tax Liability		56,000
	Income Tax Payable		41,750
	(To record Income Tax Expense for the period.)