Question

Tru’s pretax accounting income for 2018 was $110 million. In its income statement, Tru reported interest income of $15 million, unrelated to the land sales, for which the company’s position is that the interest is not taxable. Accordingly, the interest was not reported on the tax return. There are no differences between accounting income and taxable income other than those described above. The enacted tax rate is 40 percent.

Management believes the tax position taken on the land sales has a greater than 50% chance of being upheld based on its technical merits, but the position taken on the interest has a less than 50% chance of being upheld. It is further believed that the following likelihood percentages apply to the tax treatment of the land sales ($ in millions):

Amount Qualifying for Installment Sales Treatment			Percentage Likelihood of Tax Treatment Being Sustained
$	60			20	%
	50			20	%
	40			20	%
	30			20	%
	20			20	%

Required:
1. What portion of the tax benefit of tax-free interest will Tru recognize on its 2018 tax return?
2. What portion of the tax benefit of tax-free interest will Tru recognize on its 2018 financial statements?
3-a. What portion of the tax on the $60 million income from the plots sold on an installment basis will Tru defer on its 2018 tax return?
3-b. What portion of the tax on the $60 million income from the plots sold on an installment basis will Tru defer in its 2018 financial statements?
4. Prepare the journal entry to record income taxes in 2018 assuming full recognition of the tax benefits in the financial statements of both differences between pretax accounting income and taxable income.
5. Prepare the journal entry to record income taxes in 2018 assuming the recognition of the tax benefits in the financial statements you indicated in requirements 1-3.

Answer 1

First 4 questions:

Answer 1:
Since the likelihood of the tax treatment being upheld is less than 50%
The interest income	15 million
Tax rate	40%
Tax benefit to be recognized in tax return ($' million)	6
Answer 2:
Since the interest income has already been recognized in the financial statements no further need to recognize any amount in respect of the tax free interest
Answer 3a:
Sales	60 million
Likelihood of the sales to be recognized at $60m	20%
Thus, the chances of other amount for sales treatment	80%
Amount to be deferred	48
Answer 3b:
Amount of sales	60 million
Assuming equal annual instalment for 5 years	12 million
Thus, amount to be recognized in the financial statements for 2018	12 million
Accordingly, amount to be deferred	48 million
Answer 4:
Pre-tax accounting income	110 million
Less: Interest income (tax free)	15 million
Taxable income	95 million
Tax @40%	38 million	38
Journal entry
Particulars	Debit ($'m)	Credit ($'m)
Profit and loss account	38
Provision for taxation		38
(Being provision for taxation made in the financial statement)