Question

The long-term liabilities section of CPS Transportation’s December 31, 2015, balance sheet included the following:

a.  A lease liability with 15 remaining lease payments of $10,000 each, due annually on January 1:

Lease liability	$76,061
Less: Current portion	2,394
	$73,667

The incremental borrowing rate at the inception of the lease was 11% and the lessor’s implicit rate, which was known by CPS Transportation, was 10%.

b.  A deferred income tax liability due to a single temporary difference. The only difference between CPS Transportation’s taxable income and pretax accounting income is depreciation on a machine acquired on January 1, 2015, for $500,000. The machine’s estimated useful life is five years, with no salvage value. Depreciation is computed using the straight-line method for financial reporting purposes and the MACRS method for tax purposes. Depreciation expense for tax and financial reporting purposes for 2016 through 2019 is as follows:

Year	MACRS Depreciation	Straight-line Depreciation	Difference
2016	$160,000	$100,000	$60,000
2017	80,000	100,000	(20,000)
2018	70,000	100,000	(30,000)
2019	60,000	100,000	(40,000)

The enacted federal income tax rates are 35% for 2015 and 40% for 2016 through 2019. For the year ended December 31, 2016, CPS’s income before income taxes was $900,000.

On July 1, 2016, CPS Transportation issued $800,000 of 9% bonds. The bonds mature in 20 years and interest is payable each January 1 and July 1. The bonds were issued at a price to yield the investors 10%. CPS records interest at the effective interest rate.

Required:

1.  Determine CPS Transportation’s income tax expense and net income for the year ended December 31, 2016.

2.  Determine CPS Transportation’s interest expense for the year ended December 31, 2016.

3.  Prepare the long-term liabilities section of CPS Transportation’s December 31, 2016, balance sheet.

Answer 1

Answer

1.

CPS Transportation’s income tax expense and net income for the year ended December 31, 2016:

Particulars	Amount	Amount
Income before income taxes		$900000
Less: Income tax expense:
1.For current year([900000-60000]*40%)	$336000
2.Deferred income tax expense(W.N.)	$24000	($360000)
Net income		$540000

Deferred income tax expense = (Reversal of temporary differences from depreciation giving rise to future taxable amounts - Dec. 31, 2015 deferred tax liability:Temporary difference-depreciation)*40%

Deferred income tax expense = (20000+30000+40000) - (-60000+20000+30000+40000) = 60000*40% = $24000

2.

Capital lease obligation on Jan. 1 – Dec. 31: ($73,667* x 10%) = $7367

The entries at theend of 2010 and beginning of 2011 were:

Date	Particulars	Dr	Cr
on dec.31,2015(Adjusting entry)	Interest expense (10% x $76,061)	7606
	Interest payable (on Jan. 1, 2011)		7606
Jan. 1, 2016	Interest payable (10% x $76,061)	7606
	Lease liability (to balance)	2394
	Cash (annual payment)		10000

Entry to record interest:

Date	Particulars	Dr	Cr
	Interest expense (5% x $731,367)	36568
	Discount on note payable (difference)		568
	Cash (4.5% x $800,000)		36000

Present value (price) of the bonds :

For interest =800000*9%/2 = 36000*17.15909 = $617727

For principal =800000          =800000*0.14205 = $113640

Total PV for bonds                                      = $731367 (n=40,i=5%)

Total interest =731367*10%/2 =$36568

3.

Long-term liabilities:

Particulars	Amount	Amount
Lease liability - 14 payments of $10,000:
due annually on January 1	$73,667
Less:current portion ($10,000 – 7,367)	($2633)	$71034
9% bonds payable due June 30, 2029	$800000
Less: unamortized discount	($68065)	$731935
Deferred income tax liability		$36000
Total long-term liabilities		$838969