Question

Deferential Tacks Corporation began operations in 2016, reporting $260,000 income before tax in its GAAP income statement. The enacted tax rate was 35% in 2016 and is expected to be 30% in 2017 and beyond. The following GAAP versus tax differences arose in 2016:

1. Bad debt expense accrued in 2016 was $5,000. Write-offs of uncollectible accounts in 2016 were $1,200. Write-offs are taken on all account balances that are six months old.
2. The company reported cash received on one-year subscriptions of $300,000 for GAAP and Tax purposes. Unearned revenue on that amount was $140,000 on the December 31, 2016 year-end balance sheet.
3. Depreciation on Property, Plant and Equipment was $65,000 for financial reporting purposes and $80,000 for tax purposes. Property, Plant, and Equipment is correctly listed as a non-current asset on Deferential Tacks’ balance sheet.
4. Premiums on executive life insurance policies amounting to $5,000 were expensed for financial reporting purposes.
5. Non-taxable interest income of $2,500 was reported for financial reporting purposes.

Required:

1. Compute 2016 taxable income.
2. Compute the December 31, 2016 balances in the deferred tax asset and deferred tax liability accounts, separately for each timing difference that affects those balances.
3. Journal entry: Assume that Deferential Tacks expects to have adequate taxable income to utilize all future deductible amounts. Prepare the journal entry to record tax expense, tax payable, and each deferred tax account for December 31, 2016. Do not net the separate deferred tax asset and deferred tax liability accounts in the journal entry.
4. Financial statement presentation:

1. Show the Income Statement for the year ended December 31, 2016, beginning with Income before Tax.
2. Compute the effective tax rate in 2016.
3. Show the Balance Sheet presentation of current and deferred taxes on December 31, 2016. Use the information related to each timing difference to appropriately classify current and non-current deferred tax items. Assume that the company still owes the full amount of the 2016 income tax payable.

Answer 1

	Deferential Tracks Corporation:
	1. Statement Showing computation of Taxable Income
	Particulars	Amount
	Income before taxes as per financial statement	260,000.00
	(+) Accrued Bad Debt Expenses	5,000.00
	(-) Write off of bad Debt Expenses	(1,200.00)
	(+) Unearned revenue on subscriptions	140,000.00
	(+) Depreciation for Financial Reporting	65,000.00
	(-) Depreciation for Tax Purpose	(80,000.00)
	(+) Premium on life insurance of executives	5,000.00
	(-) Non Taxable Interest	(2,500.00)
	Taxable Income	391,300.00
	Tax Rate	35.00%
	Tax Amount	136,955.00
				Timing Differences
Sr.No.	Particulars	Permanent Difference / Timing Difference	Amount	Deferred Tax Asset (DTA)	Deferred Tax Liability (DTL)
1)	Accrued Bad Debt Expenses	Timing Diff.	5,000.00	5,000.00	-
2)	Write off of bad Debt Expenses	Reversal of timing diff.	1,200.00	-	-
3)	Unearned revenue on subscriptions	Timing Diff.	140,000.00	140,000.00	-
4)	Depreciation for Financial Reporting	Timing Diff.	65,000.00	-	-
5)	Depreciation for Tax Purpose	Timing Diff.	80,000.00	-	-
6)	Difference (4-5)		15,000.00	-	15,000.00
7)	Premium on life insurance of executives	Permanent Diff.	5,000.00	-	-
8)	Non Taxable Interest	Permanent Diff.	2,500.00	-	-
9)	Total			145,000.00	15,000.00
10)	Tax Rate for creation of DTA/DTL			30%	30%
11)	DTA / DTL (9*10)			43,500.00	4,500.00
12)	Net DTA (DTA - DTL)			39,000.00
	Journal Entry
Date	Account Titles	Debit	Credit
31.12.2016	Tax Expense A/c	97,955.00
	Deferred Tax Asset A/c	39,000.00
	Tax Payable A/c		136,955.00
	To record tax expenses and deferred tax assets
	Income Statement (Extract)
	Particulars	Amount	Amount
	Income before taxes		260,000.00
	Less: Tax Expenses
	(-) Current Tax	136,955.00
	(+/-) Deferred Tax	(39,000.00)	97,955.00
	Income after taxes		162,045.00
	Computation of Effective Tax Rate:
Sr.No.	Particulars	Amount
1	Income before taxes	260,000.00
2	Tax Expense	97,955.00
3	Effective Tax Rate (ETR) (2/1)	37.68%