Question

TPW, a calendar year taxpayer, sold land with a $542,000 tax basis for $785,000 in February. The purchaser paid $82,000 cash at closing and gave TPW an interest-bearing note for the $703,000 remaining price. In August, TPW received a $58,250 payment from the purchaser consisting of a $35,150 principal payment and a $23,100 interest payment. Assume that TPW uses the installment sale method of accounting.

Compute the difference between TPW’s book and tax income resulting from the installment sale method.

Is this difference favorable or unfavorable?

Using a 21 percent tax rate, compute PTR’s deferred tax asset or liability (identify which) resulting from the book/tax difference.

Answer 1

Part A

The book profit (income) made on the sales = 785,000 – 542,000 = $ 243,000

Under instalment sales method, he receives $ 82,000 cash and an interest bearing note of $ 703,000. In the current year he receives $ 58,250 on the interest bearing note (principal - $35,150 + interest – $23,100).

The gross profit % = 243,000 / 785,000 * 100 = 30.95%

The gross profit % of the cash received will be booked as a taxable income for the year (82,000 * 30.95% = $ 25,379).

The interest component received on the note will be fully booked as taxable income ($ 23,100).

On the principal component, the taxable income would be charged as a gross profit % calculated earlier (35,150 * 30.95% = $ 10,879).

Therefore, the taxable income = 25,379 + 10,879 + 23,100 = $ 59,358.

Difference = 243,000 – 59,358 = $ 183,642

Part B

The taxable income is reduced in the given case by $ 183,642. Whenever, the taxable income is reduced, it is termed as a favorable difference and hence, the difference is favorable.

Part C

Since, the company will have to pay a higher tax in the future years, we will have to book a deferred tax liability. It will be calculated as:

Deferred Tax Liability = $ 183,462 * 21% = $ 38,527.