Accounting for Income Tax-problems

by Alfredo Garcia February 22, 2005 [Send a comment to Alfredo Garcia | Print View]

MULTIPLE CHOICE QUESTIONS a1.Which of the following creates a permanent difference between financial income and taxable income? a.Interest received on municipal bonds b.Completed contract method of recognizing construction revenue c.Unearned rent revenue d.Accelerated cost recovery on plant and equipment b2.Which of the following creates a temporary difference between financial and taxable income? a.Interest on municipal bonds b.Accelerated cost recovery on plant and equipment c.Fines from violation of law d.Premiums paid for officer's life insurance (company is beneficiary) c3.The purpose of an interperiod income tax allocation is to a.allow reporting entities to fully utilize tax losses carried forward from a previous year. b.allow reporting entities whose tax liabilities vary significantly from year to year to smooth payments to taxing agencies. c.recognize an asset or liability for the tax consequences of temporary differences that exist at the balance sheet date. d.amortize the deferred tax liability shown on the balance sheet. d4.The result of interperiod income tax allocation is that a.wide fluctuations in a company's tax liability payments are eliminated. b.tax expense shown in the income statement is equal to the deferred taxes shown on the balance sheet. c.tax liability shown in the balance sheet is equal to the deferred taxes shown on the previous year's balance sheet plus the income tax expense shown on the income statement. d.tax expense shown on the income statement is equal to income taxes payable for the current year plus or minus the change in the deferred tax asset or liability balances for the year. a5.Which of the following temporary differences ordinarily creates a deferred tax asset? a.Accrued warranty costs b.Depreciation c.Installment sales d.Amortization of goodwill c6.An example of a "deductible temporary difference" occurs when

a. the installment sales method is used for tax purposes, but the accrual method of recognizing sales revenue is used for financial reporting purposes. b. accelerated depreciation is used for tax purposes but straight line depreciation is used for accounting purposes. c. warranty expenses are recognized on the accrual basis for financial reporting purposes but recognized as the warranty conditions are met for tax purposes. d. the completed-contract method of recognizing construction revenue is used for tax purposes, but the percentage-of-completion method is used for financial reporting purposes. a7.Which of the following situations would require interperiod income tax allocation procedures? a.A temporary difference exists because the tax basis of capital equipment is less than its reported amount in the financial statements. b.Proceeds from an insurance policy on capital equipment lost in a fire exceed the book value of the equipment. c.Last periods ending inventory was understated causing both net income and income tax expense to be understated. d.Nontaxable interest payments are received on municipal bonds. d8.An item that would create a permanent difference in pretax financial and taxable incomes would be a.using accelerated depreciation for tax purposes and straight-line depreciation for book purposes. b.purchasing equipment previously leased with an operating lease in prior years. c.using the percentage-of-completion method on long-term construction contracts. d.paying fines for violation of laws. d9.Which of the following is the most likely item to result in a deferred tax asset? a. Using accelerated depreciation for tax purposes but straight line depreciation for accounting purposes b. Using the completed-contract method of recognizing construction revenue tax purposes, but using percentage-of-completion method for financial reporting purposes c. Prepaid expenses d. Unearned revenues a10.Which of the following arguments is supportive of allocation of income taxes? a.Future predictions of net income are enhanced when income taxes are allocated. b.Income tax expense computed under interperiod tax allocation is a better predictor of future cash flows than income taxes actually paid. c.Income tax is not an expense; it is a sharing of profits with government. d.Income tax expense based on actual payments is more understandable to users than allocated income taxes. d11.Which of the following temporary differences ordinarily results in a deferred tax liability?

a.Accrued warranty costs b.Subscription revenue received in advance c.Unrealized losses on marketable securities d.Depreciation d12.When enacted tax rates change, the asset and liability method of interperiod tax allocation recognizes the rate change as a.a cumulative effect adjustment. b.an adjustment to be netted against the current income tax expense. c.a separate charge to the current year's net income. d.a separate charge or benefit to income tax expense. c13.Recognizing tax benefits in a loss year due to a loss carryforward requires a.only a footnote disclosure. b.creating a new carryforward for the next year. c.creating a deferred tax asset. d.creating a deferred tax liability. a14.A company would most likely choose the carryforward option for a net operating loss if the company expected a.higher tax rates in the future compared to the past. b.lower tax rates in the future compared to the past. c.lower earnings in the future compared to the past. d.higher earnings in the future compared to the past. a15.All of the following can result in a temporary difference between pretax financial income and taxable income except for a.payment of premiums for life insurance. b.depreciation expense. c.contingent liabilities. d.product warranty costs. c16.Which of the following items results in a temporary difference deductible amount for a given year? a.Premiums on officer's life insurance (company is beneficiary) b.Premiums on officer's life insurance (officer is beneficiary) c.Vacation pay accrual d.Accelerated depreciation for tax purposes; straight-line for financial reporting purposes d17.Which of the following items results in a temporary difference taxable amount for a given year? a.Premiums on officer's life insurance (company is beneficiary) b.Premiums on officer's life insurance (officer is beneficiary) c.Vacation pay accrual d.Accelerated depreciation for tax purposes; straight-line for financial reporting

purposes d18.Alpha Company reported net incomes in 2001 and 2002 before sustaining a significant operating loss in 2003. All of the 2003 loss can be carried back against the income of 2001 and 2002 for purposes of determining the companys 2003 income tax liability. How should the carryback be presented in the companys 2003 financial statements? a.As an extraordinary item in the income statement b.As a revenue from operations in the income statement c.As the correction of an error in the retained earnings statement d.As a reduction in the operating loss on the income statement for the year 2003 a19.Intraperiod income tax allocation arises because a.items included in the determination of taxable income may be presented in different sections of the financial statements. b.income taxes must be allocated between current and future periods. c.certain revenues and expenses appear in the financial statements either before or after they are included in taxable income. d.certain revenues and expenses appear in the financial statements but are excluded from taxable income. b20.Assuming no prior period adjustments, would the following allocations affect net income? Interperiod Tax Intraperiod Income Tax Allocation Tax Allocation a. Yes Yes b. Yes No c. No Yes d. No No c21.Which of the following statements is not correct? a.All current deferred tax liabilities and assets shall be offset and presented as a single amount on the balance sheet. b.Deferred tax assets related to carryforwards shall be classified as current or noncurrent on the balance sheet based on their expected date of reversal. c.All current and noncurrent deferred tax assets shall be offset and presented as a single amount on the balance sheet. d.Deferred tax liabilities and assets shall be classified as current or nocurrent on the balance sheet based on the classification of the asset or liability giving rise to the deferred tax item. b22.A deferred tax liability arising from the use of an accelerated method of depreciation for tax purposes and the straight-line method for financial reporting purposes would be classified on the balance sheet as a.a current liability. b.a noncurrent liability.

c.a current liability for the portion of the temporary difference reversing within a year and a noncurrent liability for the remainder. d.an offset to the accumulated depreciation reported on the balance sheet. c23.International accounting standards currently are moving toward the a.no-deferral approach. b.partial recognition approach. c.comprehensive recognition approach. d.discounted comprehensive recognition approach. b24.If all temporary differences entering into the determination of pretax accountingincome are considered in the computation of deferred taxes and income tax expense, then a.the no-deferral approach is being applied. b.the comprehensive recognition approach is being applied. c.the partial recognition approach is being applied. d.the net-of-tax method is being applied. d25.The asset-liability method of interperiod tax allocation currently required by U.S. GAAP is an example of the a.discounted comprehensive recognition approach. b.no-deferral approach. c.partial recognition approach. d.comprehensive recognition approach. b26.Historically, the United Kingdom has recognized only those deferred tax liabilities expected to crystallize. The term crystallize is most nearly synonymous with the term a.amortized. b.realized. c.recognized. d.liquidated. a27. On the statement of cash flows using the indirect method, an increase in the deferred tax liability would be shown as a.an addition to net income. b.a deduction from net income. c.an increase in investing activities. d.an increase in financing activities. b28.In 2002, Eric Corporation reported $90,000 net income before income taxes. The income tax rate for 2002 was 30 percent. Eric had an unused $60,000 net operating loss carryforward arising in 2001 when the tax rate was 35 percent. The income tax expense Eric would report for 2002 would be a.$6,000. b.$9,000.

c.$10,500. d.$27,000. a29.The Gayle Corporation reported a $66,000 operating loss in 2002. In the preceding three years, Gayle reported the following income before taxes and paid the indicated income taxes: Year Income Taxes Tax Rate 1999 $36,000 $10,800 30% 2000 24,000 8,400 35% 2001 48,000 16,200 35% The amount of tax benefit to be reported in 2002 arising from the tax carryback provisions of the current tax code would be a.$23,100. b.$22,500. c.$21,300. d.$19,200. c30.The Indy Company had taxable income of $12,000 during 2002. Indy used accelerated depreciation for tax purposes ($3,400) and straight line depreciation for accounting purposes ($2,000). Assuming Indy had no other temporary differences, what would the companys pretax accounting income be for 2002? a. $1,400 b. $6,600 c. $13,400 d. $17,400 b31.The following information is taken from Blackhawk Corporation's 2002 financial records: Pretax accounting income $1,500,000 Excess tax depreciation (45,000) Taxable income $1,455,000 Assume the taxable temporary difference was created entirely in 2002 and will reverse in equal net taxable amounts in each of the next three years. If tax rates are 40 percent in 2002, 35 percent in 2003, 35 percent in 2004, and 30 percent in 2005, then the total deferred tax liability Blackhawk should report on its December 31, 2002, balance sheet is a.$13,500. b.$15,000. c.$15,750. d.$18,000. d32.The following information was taken from Buccaneer Corporation's 2002 income statement: Income before income taxes $ 1,500,000 Income tax expense:

Current $564,000 Deferred 36,000 600,000 Net income $ 900,000 Buccaneers' first year of operations was 2002. The company has a 30 percent tax rate. Management decided to use accelerated depreciation for tax purpose and the straight-line method of depreciation for financial reporting purposes. The amount charged to depreciation expense in 2002 was $600,000. Assuming no other differences existed between book income and taxable income, what amount did Buccaneer deduct for depreciation on its tax return for 2002? a.$480,000 b.$570,000 c.$600,000 d.$720,000 a33.Warren Corporation began operations in 1997 and had operating losses of $400,000 in 1998 and $300,000 in 1999. For the year ended December 31, 2000, Warren had a pretax financial income of $600,000. For 1998 and 1999, assume an enacted tax rate of 30 percent, and for 2000 a 35 percent tax rate. There were no temporary differences in any of the years. In Warren's 2000 income statement, how much should be reported as income tax expense? a.$0 b.$30,000 c.$180,000 d.$210,000 b34.On December 31, 1999, Alton, Inc., reported a current deferred tax liability of $140,000 and a noncurrent deferred tax asset of $40,000. At the end of 2000, Alton reported a current deferred tax liability of $100,000, and a noncurrent deferred tax liability of $44,000. The deferred tax expense for 2000 is a.$144,000. b.$44,000. c.$36,000. d.$4,000. d35.Eden Company had pretax accounting income of $24,000 during 2002. Eden's only temporary difference for 2002 relates to a sale made in 2000 and recognized for accounting purposes at that time. However, Eden uses the installment sales method of revenue recognition for tax purposes. During 2002 Eden collected a receivable from the 2000 sale which resulted in $6,000 of income under the installment sales method. Eden's taxable income for 2002 would be a.$6,000. b.$18,000. c.$24,000. d.$30,000.

c36.Begal Corporation paid $20,000 in January of 2002 for premiums on a two-year life insurance policy which names the company as the beneficiary. Additionally, Begal Corporation's financial statements for the year ended December 31, 2002 revealed the company paid $105,000 in taxes during the year and also accrued estimated losses on disposal of unused plant facilities of $200,000. Assuming these facilities were sold in February of 2003 (at which time a $200,000 loss was recognized for tax purposes) and that Begal's tax rate is 30 percent for both 2002 and 2003, what amount should Begal report as asset for net deferred income taxes on its 2002 balance sheet? a.$54,000 b.$57,000 c.$60,000 d.$66,000 c37.Dodger Corporation reported a loss for both financial reporting purposes and tax reporting purposes of $231,000 in 2002. For financial reporting purposes, Dodger reported income before taxes for years 1999-2001 as listed below: 1999 $ 66,000 2000 99,000 2001 132,000 Assuming Dodger's tax rate is 30 percent in all periods, and that the company uses the carryback provisions, what amount should appear in Dodger's statements for financial reporting purposes as a net loss in 2002? a.$0 b.$69,300 c.$161,700 d.$234,300 b38.Analysis of the assets and liabilities of Marie Corp. on December 31, 2002, disclosed assets with a tax basis of $1,000,000 and a book basis of $1,300,000. There was no difference in the liability basis. The difference in asset basis arose from temporary differences that would reverse in the following years: 2003 $80,000 2004 70,000 2005 72,000 2006 40,000 2007 38,000 The enacted tax rates are 30 percent for the years 2002-2005 and 35 percent for 20062009. The total deferred tax liability on December 31, 2002, should be a.$105,000. b.$93,900. c.$90,000. d.$69,000. c39.Schaeffer Products, Inc., reported an excess of warranty expense over

warranty deductions of $72,000 for the year ended December 31, 2002. This temporary difference will reverse in equal amounts over the years 2003 to 2005. The enacted tax rates are as follows: 2002 40% 2003 35% 2004 30% 2005 25% The reporting for this temporary difference at December 31, 2002, would be a.a deferred tax liability of $28,800. b.a deferred tax asset of $28,800. c.a current deferred tax liability of $8,400 and a noncurrent deferred tax liability of $13,200. d.a current deferred tax asset of $8,400 and a noncurrent deferred tax asset of $13,200. d40.In 2003, The Worf Company, reported pretax financial income of $500,000. Included in that pretax financial income was $90,000 of nontaxable life insurance proceeds received as a result of the death of an officer; $120,000 of warranty expenses accrued but unpaid as of December 31, 2003; and $20,000 of life insurance premiums for a policy for an officer. Assuming that no income taxes were previously paid during the year and assuming an income tax rate of 40 percent, the amount of income taxes payable on December 31, 2003, would be a.$180,000. b.$200,000. c.$212,000. d.$220,000. b41.Fieldcrest Company, newly formed on January 1, 2002, prepared a temporary difference reversal schedule at the end of 2003 that disclosed the following taxable income (loss) amounts before application of the carryback/carryforward rules: 2002 $ 64,000 2003 (128,000) 2004 (12,000) 2005 80,000 2006 20,000 The enacted tax rate for all years was 30 percent. Using the provisions of FASB Statement No. 109, the total noncurrent deferred tax liability on December 31, 2003, was a.$0. b.$7,200. c.$10,800. d.$30,000. b42.For three consecutive years, 2000-2002, Twins Corporation has reported income before taxes of $100,000 for both financial reporting purposes and tax reporting purposes. During this time, Twins income tax rates were as follows:

2000 2001 2002

20% 25% 30%

In 2003, Twins tax rate changed to 35 percent. Also in 2003, the company reported a loss for both financial reporting and tax reporting purposes of $100,000. Assuming the company uses the carryback provisions, the amount Twins should report as an income tax refund receivable in 2003 is a.$20,000. b.$25,000. c.$30,000. d.$35,000. c43.Viking Corporation reported depreciation of $250,000 on its 2002 tax return. However, in its 2002 income statement, Viking reported depreciation of $100,000. The difference in depreciation is a temporary difference that will reverse over time. Assuming Viking's tax rate is constant at 30 percent, what amount should be added to the deferred income tax liability in Viking's December 31, 2002, balance sheet? a.$30,000 b.$37,500 c.$45,000 d.$75,000 b44.Cowboy Corporation reported depreciation of $450,000 on its 2002 tax return. However, in its 2002 income statement, Cowboy reported depreciation of $300,000--as well as $30,000 interest revenue on tax-free bonds. The difference in depreciation is only a temporary difference, and it will reverse equally over the next three years. Cowboy's enacted income tax rates are as follows: 2002 35% 2003 30% 2004 25% 2005 20% What amount should be included in the deferred income tax liability in Cowboy's December 31, 2002, balance sheet? a.$30,000 b.$37,500 c.$45,000 d.$52,500 c45.The books of the Tracker Company for the year ended December 31, 2002, showed pretax income of $360,000. In computing the taxable income for federal income tax purposes, the following timing differences were taken into account: Depreciation deducted for tax purposes in excess of depreciation recorded on the books $16,000 Income from installment sale reportable for tax

purposes in excess of income recognized on the books 12,000 What should Tracker record as its current federal income tax liability at December 31, 2002, assuming a corporate income tax rate of 30 percent? a.$99,600 b.$103,200 c.$106,800 d.$108,000 c46.Frey Corporation's income statement for the year ended December 31, 2002, shows pretax income of $1,000,000. The following items are treated differently on the tax return and in the accounting records: Tax Accounting Return Records Rent income $ 70,000 $120,000 Depreciation expense 280,000 220,000 Premiums on officers' life insurance -- 90,000 Assume that Frey's tax rate for 2002 is 30 percent. What is the amount of income tax payable for 2002? a.$360,000 b.$320,000 c.$294,000 d.$267,000 c47.Inventive Corporations income statement for the year ended December 31, 2002, shows pretax income of $300,000. The following items are treated differently on the tax return and in the accounting records: Tax Accounting Return Records Warranty expense $170,000 $185,500 Depreciation expense 150,000 100,000 Premiums on officers' life insurance -- 60,000 Assume that Inventives tax rate for 2002 is 40 percent. What is the current portion of Inventive's total income tax expense for 2002? a.$106,200 b.$120,200 c.$130,200 d.$144,200

The following information relates to questions 48-50: The Hart Company paid $400,000 in income taxes for the year ended December 31, 2002. Of these taxes, $23,000 related to an extraordinary gain that was taxed at 25%. The company discontinued one of its business segments during 2002 and realized a tax savings of $55,000 from the loss on disposition of the segment. The loss was treated for tax purposes as an ordinary loss and was deducted from ordinary income that was taxed at 40%. Included in the $400,000 tax payment was $12,000 resulting from a gain on the sale of equipment. The tax rate on the gain was 25%. All other income items were from normal operations and were taxed at 40%. c48.Income from continuing operations for Hart Company for the year 2002 was a.$1,000,000. b.$1,080,000. c.$1,098,000. d.$1,050,000. a49.Income taxes from continuing operations for Hart Company for the year 2002 was a.$432,000. b.$420,000. c.$400,000. d.$455,000. b50.Operating income for Hart Company for the year 2002 was a.$1,000,000. b.$1,050,000. C.$1,098,000. d.$1,080,000. c51.During a year, Great Northern Company reported income tax expense of $200,000. The amount of taxes currently payable remained unchanged from the beginning to the end of the year. The deferred tax liability classified as noncurrent that resulted from the use of MACRS for tax purposes and straight-line depreciation for financial reporting purposes, increased from $40,000 at the beginning of the year to $44,000 at the end of the year. How much cash was paid for income taxes during for the year? a.$156,000 b.$160,000 c.$196,000 d.$206,000 a52.For the current year, Northern Pacific Company reported income tax expense of $45,000. Income taxes payable at the end of the prior year were $20,000 and at the end of the current year were $27,000. The deferred tax liability classified as noncurrent that resulted from the use of MACRS for tax purposes and straight-line depreciation for

financial reporting purposes increased from $18,000 at the beginning of the current year to $23,000 at the end of the current year. How much cash was paid for income taxes during the year? a.$33,000 b.$45,000 c.$38,000 d.$47,000 a53.For the current year, Santa Fe Company reported income tax expense of $195,000. Income taxes payable at the end of the prior year were $125,000 and at the end of the current year were $130,000. The deferred tax liability classified as noncurrent that resulted from the use of MACRS for tax purposes and straight-line depreciation for financial reporting purposes increased from $120,000 at the beginning of the current year to $123,000 at the end of the current year. How much cash was paid for income taxes during the year? a.$187,000 b.$197,000 c.$195,000 d.$190,000 a54.For the current year, Northern Pacific Company reported income tax expense of $11,000. Income taxes payable at the end of the prior year were $9,000 and at the end of the current year were $10,000. The deferred tax liability classified as noncurrent that resulted from the use of MACRS for tax purposes and straight-line depreciation for financial reporting purposes increased from $11,000 at the beginning of the current year to $13,000 at the end of the current year. How much cash was paid for income taxes during the year? a. $8,000 b.$10,000 c.$11,000 d. $9,000 PROBLEMS Problem 1 Garrison Designs, Inc., a corporation organized on January 1, 1993, reported the following incomes (losses) for the ten-year period, 1993-2002: Year Income (Loss) Income Tax Rate Income Tax Paid 1993 16,000 50% $ 8,000 1994 (40,000) 50 0 1995 16,000 48 7,680 1996 24,000 48 11,520 1997 (32,000) 45 0 1998 16,000 42 6,720 1999 32,000 42 13,440 2000 64,000 34 21,760

2001 2002

80,000 34 27,200 (16,000) 30 0

Applying the carryback provisions in the tax law, compute the net amount of taxes paid (amounts paid less refunds) for the ten-year period ending December 31, 2002. Solution 1 LO3 Income taxes paid through December 31, 1998, net to zero because the $40,000 net operating loss in 1994 and the $32,000 net operating loss in 1997 are applied against the entire income earned for the years 1993, 1995, 1996, and 1998. Net taxes paid between January 1, 1999, and December 31, 2002, were: Year Net Taxes Paid 1999 $13,440 2000 (after applying 2002 loss) 16,320 2001 27,200 2002 -Total income taxes actually paid (1993 - 2002) $56,960 Problem 2 The following differences between financial and taxable income were reported by Dider Corporation for the current year. (a)Excess of tax depreciation over book depreciation $60,000 (b)Interest revenue on municipal bonds 9,000 (c)Excess of estimated warranty expense over actual expenditures 54,000 (d)Unearned rent received 12,000 (e)Fines paid 30,000 (f)Excess of income reported under percentage-of-completion accounting for financial reporting over completed-contract accounting used for tax reporting 45,000 (g)Interest on indebtedness incurred to purchase tax-exempt securities 3,000 (h)Unrealized losses on marketable securities recognized for financial reporting 18,000 Assume that Dider Corporation had pretax accounting income [before considering items (a) through (h)] of $900,000 for the current year. Compute the taxable income for the current year. Solution 2 LO2

Pretax financial income $ 900,000 Add (deduct) permanent differences: (b) Tax-exempt interest (9,000) (e) Fines paid 30,000 (g) Interest expense on funds used to purchase tax-exemptsecurities 3,000 Subtotal $ 924,000 Add (deduct) timing differences: (a)Excess of tax over book depreciation (60,000) (c)Excess of warranty expense over actual expenditures 54,000 (d)Unearned rent received 12,000 (f)Excess of percentage-of-completion income over completed contract income (45,000) (h)Unrealized loss on marketable securities 18,000 Taxable income $ 903,000 Problem 3 Walsh Services computed pretax financial income of $220,000 for its first year of operations ended December 31, 2002. In preparing the income tax return for the year, the tax accountant determined the following differences between 2002 financial income and taxable income. (1) Nondeductible expenses $40,000 (2) Nontaxable revenues 14,000 (3) Temporary difference--Installment sales reported in financial income but not in taxable income 70,000 The temporary difference is expected to reverse in the following pattern. 2003 $14,000 2004 32,000 2005 24,000 $70,000 The enacted tax rates for this year and the next three years are as follows: 2002 40% 2003 35% 2004 32% 2005 30% Use the provisions of FASB Statement No. 109. (1) Prepare a schedule showing the reversal of the temporary differences and the computation of income taxes payable and deferred tax assets or liabilities as of December 31, 2002. (2) Prepare journal entries to record income taxes payable and deferred income taxes.

(3) Prepare the income statement for Walsh Services beginning with Income from continuing operations before income taxes for the year ended December 31, 2002. Solution 3 LO4 (1)

Reversal Years 2002 2003 2004 2005 Pretax financial income $220,000 Nondeductible expense 40,000 Nontaxable revenue (14,000) Taxable financial income $246,000 Temporary difference: Gross profit on installment sales (70,000) $14,000 $32,000 Taxable income $ 176,000 $14,000 $32,000 $24,000 Enacted tax rate 40% 35% 32% 30% Income taxes payable $ 70,400 Deferred tax liability: Current $ 4,900 Noncurrent $10,240 $ 7,200

$24,000

(2) 2002 Journal Entries: Income Tax Expense--Current KKKKKKKKK 70,400 Income Taxes Payable KKKKKKKKKK.. 70,400 Income Tax Expense--Deferred KKKKKKKK. 22,340 Deferred Tax Liability--Current KKKKKKK. 4,900 Deferred Tax Liability--Noncurrent KKKKKK 17,440 (3) 2002 Income Statement Presentation: Income from continuing operations before income taxes $220,000 Less income taxes: Current provision $ 70,400 Deferred provision 22,340 92,740 Income from continuing operations $127,260 Problem 4 Millcroft Inc. computed a pretax financial income of $40,000 for the first year of its operations ended December 31, 2002. Analysis of the tax and book basis of its liabilities disclosed $360,000 in unearned rent revenue on the books that had been recognized as taxable income in 2002 when the cash was received. The unearned rent is expected to be recognized on the books in the following pattern. 2003 KKKKKKKKKKKKKKKKKK..$ 90,000 2004 160,000

2005 KKKKKKKKKKKKKKKKKK.. 70,000 2006 KKKK.KKKKKKKKKKKKKK 40,000 $360,000 The enacted tax rates for this year and the next four years are as follows: 2002 40% 2003 36% 2004 33% 2005 30% 2006 32% Use the provisions of FASB Statement No. 109. (1) Prepare a schedule showing the reversal of the temporary difference and the computation of income taxes payable and deferred tax assets or liabilities as of December 31, 2002.(2) Prepare journal entries to record income taxes payable and deferred income taxes. (3) Prepare the income statement for Millcroft beginning with Income from continuing operations before income taxes for the year ended December 31, 2002. Solution 4 LO4 (1)

Reversal Years 2002 2003 2004 2005 2006 Taxable financial income $ 40,000 $ 0 $ 0 $ 0 $ 0 Temporary differences: Unearned rent revenue 360,000 Rent revenue earned 0 (90,000) (160,000) (70,000) (40,000) Taxable income (loss) $ 400,000 $(90,000) $(160,000) $(70,000) $(40,000) Loss carryback: 2003 carryback (90,000) 90,000 2004 carryback (160,000) 160,000 2005 carryback (70,000) 70,000 Net taxable (deductible) amount $ 80,000 $ 0 $ 0 $ 0 $(40,000) Enacted tax rate 40% 36% 30% 30% 32% Income taxes payable (40% x $400,000) $160,000 Deferred tax asset: Current (40% x $90,000) 36,000 Noncurrent (40% x $160,000) 64,000 (2) 2002 Journal Entries: Income Tax Expense--Current 160,000 Income Taxes Payable 160,000

Deferred Tax Asset--Current 36,000 Deferred Tax Asset--Noncurrent 92,000 Income Tax Benefit--Deferred 128,000 (3) 2002 Income Statement Presentation: Income from continuing operations before income taxes $40,000 Less income taxes: Current provision $160,000 Deferred benefit (128,000) 32,000 Income from continuing operations $ 8,000 Problem 5 Radford Appliances computed a pretax financial loss of $60,000 for the first year of its operations ended December 31, 2002. Analysis of the tax and book basis of its liabilities disclosed $80,000 in accrued warranty expenses on the books that had not been deductible from taxable income in 2002, but would be deductible in future years when the warranty expenses were paid. The future warranty payments are expected to occur in the following pattern. 2003 $14,000 2004 36,000 2005 18,000 2006 12,000 $80,000 The enacted tax rates for this year and the next four years are as follows: 2002 40% 2003 35% 2004 32% 2005 30% 2006 30% Use the provisions of FASB Statement No. 109. (1) Prepare a schedule showing the reversal of the temporary difference and the computation of income taxes payable and deferred tax assets or liabilities as of December 31, 2002. (2) Prepare journal entries to record income taxes payable and deferred income taxes. (3) Prepare the income statement for Radford beginning with "Income from continuing operations before income taxes" for the year ended December 31, 2002. Solution 5

LO4 (1)

Reversal Years 2002 2003 2004 2005 2006 Taxable financial income $(60,000) $ 0 $ 0 $ 0 $ 0 Temporary differences: Estimated warranty payment in future years 80,000 Deductible amount-warranty payments (14,000) (36,000) (18,000) (12,000) Taxable income (loss) $ 20,000 $(14,000) $(36,000) $(18,000) $(12,000) Loss carryback: 2003 carryback (14,000) 14,000 2004 carryback (6,000) 6,000 Net taxable (deductible amount) $ 0 $ 0 $(30,000) $(18,000) $(12,000) Enacted tax rate 40% 35% 32% 30% 30% Income taxes payable (40% x $20,000) $8,000 Deferred tax asset: Current (40% x $14,000) 5,600 Noncurrent (40% x $6,000) 2,400 (2) 2002 Journal Entries Income Tax Expense--Current 8,000 Income Taxes Payable 8,000 Deferred Tax Asset--Current 5,600 Deferred Tax Asset--Noncurrent 2,400 Income Tax Benefit--Deferred 8,000 (3) 2002 Income Statement Presentation: Loss from continuing operations before income taxes $(60,000) Less income taxes: Current provision $8,000 Deferred benefit (8,000) 0 Loss from continuing operations $(60,000) Problem 6 Seta Associates computed a pretax financial income of $280,000 for the first year of its operations ended December 31, 2002. Included in financial income was $20,000 of nondeductible expense and $70,000 gross profit on installment sales that was deferred for tax purposes until the installments were collected. The temporary differences are expected to reverse in the following pattern.

Gross Profit on Collections 2003 $20,000 2004 30,000 2005 20,000 $70,000 The enacted tax rates for this year and the next three years are as follows: 2002 40% 2003 35% 2004 32% 2005 30% (1) Prepare a schedule showing the reversal of the temporary differences and the computation of income taxes payable and deferred tax assets or liabilities as of December 31, 2002. (2) Prepare journal entries to record income taxes payable and deferred income taxes.

(3) Prepare the income statement for Seta beginning with "Income from continuing operations before income taxes" for the year ended December 31, 2002. Solution 6 LO4 (1) Reversal Years 2002 2003 2004 2005 Pretax financial income (loss) $280,000 Nondeductible expense 20,000 Taxable financial income (loss) $300,000 Temporary difference: Gross profit on installment sales (70,000) Taxable amount--collections $20,000 $30,000 $20,000 Taxable income (loss) $230,000 $20,000 $30,000 $20,000 Enacted tax rate 40% 35% 32% 30% Income taxes payable (40% x $230,000) $92,000 Deferred tax liability: Current (35% x $20,000) 7,000 Noncurrent (32% x $30,000) + (30% x 20,000) 15,600 Under the provisions of the proposed modification to FASB Statement No. 109, the classification of the deferred tax liability into current and noncurrent portions follows the classification of the underlying installment receivable.

(2) 2002 Journal Entries Income Tax Expense--Current 92,000 Income Taxes Payable 92,000 Income Tax Expense--Deferred 22,600 Deferred Tax Liability--Current 7,000 Deferred Tax Liability--Noncurrent 15,600 (3) 2002 Income Statement Presentation: Income from continuing operations before income taxes Less income taxes: Current provision $92,000 Deferred provision 22,600 114,600 Income from continuing operations $165,400 $280,000

Problem 7 Cardinal Industries computed a pretax financial income of $118,500 for the first year of its operations ended December 31, 2002. Cardinal uses an accelerated cost recovery method on its tax return, and straight-line depreciation on its books. The difference between the tax and book deduction for depreciation over the five-year life of the assets acquired in 1999 are as follows: 2002 $(24,000) 2003 (39,000) 2004 (9,000) 2005 KKKKKKKKKKKKKKKKK 30,000 2006 KKKKKKKKKKKKKKKKK 42,000 $0 The enacted tax rates for this year and the next four years are as follows: 2002 40% 2003 38% 2004 36% 2005 35% 2006 32% Use the provisions of FASB Statement No. 109 and assume that it is more likely than not that income will be sufficient in all future years to realize any deductible amounts. (1) Prepare a schedule showing the pattern of depreciation differences, the computation of income taxes payable, and deferred tax assets or liabilities as of December 31, 2002. (2) Prepare journal entries to record income taxes payable and deferred income taxes. (3) Prepare the income statement for Cardinal Industries beginning with "Income from continuing operations before income taxes" for the year ended December 31, 2002.

Solution 7 LO4 (1)

Reversal Years 2002 2003 2004 2005 2006 Taxable financial income $118,500 Temporary difference between tax and book depreciation (24,000) $(39,000) $(9,000) $30,000 $42,000 Taxable income (loss) $ 94,500 $(39,000) $(9,000) $30,000 $42,000 Enacted tax rate 40% 38% 36% 35% 32% Income taxes payable ($94,500 x 40%) $37,800 Deferred tax asset: Noncurrent (38% x $39,000) + (36% x $9,000) 18,060 Deferred tax liability: Noncurrent (35% x $30,000) + (32% x $42,000) 23,940 Under the provisions of FASB Statement No. 109, the classification of the deferred tax asset and liability as noncurrent follows the classification of the underlying depreciable asset. The deferred tax asset and liability can be offset and reported as a noncurrent deferred tax liability totaling $5,880 ($23,940 - $18,060). (2) 2002 Journal Entries Income Tax Expense--Current 37,800 Income Taxes Payable 37,800 Income Tax Expense--Deferred 5,880 Deferred Tax Liability--Noncurrent 5,880 (3) 2002 Income Statement Presentation: Income from continuing operations before income taxes Less income taxes: Current provision $37,800 Deferred provision 5,880 43,680 Income from continuing operations $ 74,820 $118,500

Problem 8 Halverson Company reported taxable income of $60,000 for 2002, its first year of operations. This amount reflects temporary differences between financial and taxable income that are scheduled to reverse in subsequent years as shown below. As of December 31, 2002, the enacted tax rate for 2002 and future years was 40 percent.

Temporary Difference Reversals Taxable (Deductible) Year Amounts 2003 $(24,000) 2004 27,000 2005 (36,000) 2006 (18,000) 2007 101,000 Use the provisions of FASB Statement No. 109 and assume that it is more likely than not that income will be sufficient in all future years to realize any deductible amounts. Also assume that all the temporary differences relate to noncurrent items. Compute the amount of the deferred tax assets and/or liabilities that would be reported on Halverson's balance sheet as of December 31, 2002. Solution 8 LO2 Since future tax rates are unchanging and since FASB Statement No. 109 classifies deferred tax assets and liabilities according to the classification of the underlying items and not the expected time of reversal, no scheduling is necessary in this case. Noncurrent deferred tax liability: ($50,000 x 0.40) = $20,000 Problem 9 Assume Ernst Corporation has the following income components on its income statement. Amounts are before tax. Income from continuing operations $40,000 Gain on disposal of business segment 20,000 Extraordinary gain on early extinguishment of debt 24,000 Extraordinary loss on property loss (34,000) Cumulative effect of change in depreciation method (12,000) Total income before considering income taxes 38,000 Assume further that the tax department has applied the current tax regulations and rates to Ernsts various income categories and computed the following tax information using the with and without concept required for intraperiod tax allocation: Tax on total income ($38,000) $14,400 Tax on income from continuing operations ($40,000) 16,200 Tax on total income before considering all irregular and extraordinary losses 29,000 The tax department also has computed the following incremental tax benefits and expenses on each individual gain or loss component:

Incremental tax expense--gain components: Gain on disposal $6,500 Extraordinary gain 6,700 Incremental tax benefit--loss components: Extraordinary loss 10,500 Cumulative effect 4,600 1. Compute the total tax to be allocated to all income components after income from continuing operations, the total tax benefit allocated to the two loss categories, and the total tax expense allocated to the two gain categories. 2. Allocate the total tax benefit and tax expense from (1) to the separate gain and loss components. Solution 9 LO8 (1) Tax on income from continuing operations $16,200 Less: Tax on total incomeKKKKKKKKKK... 14,400 Total tax benefit to be allocatedKKKKKKKK.. $ 1,800 Tax on total income before considering all irregular and extraordinary lossesKKKKKKK. $29,000 Less: Tax on total income KKKKKKKKKK.. 14,400 Tax benefit from loss categories $14,600 Total tax benefit from loss categories $14,600 Less: Total tax benefit to be allocated 1,800 Tax expense allocated to gain categories $12,800 (2) Allocation to gain categories: Total tax expense to allocate to gains $12,800 Incremental tax--Gain on disposal $ 6,500 Incremental tax--Extraordinary gain 6,700 Total expense on gains $13,200 Tax expense allocated to gain on disposal [($6,500 i $13,200) x $12,800] $ 6,303 Tax expense allocated to extraordinary gain [($6,700 i $13,200) x $12,800] 6,497 $12,800 Allocation to loss categories: Total tax benefit allocated to losses $(14,600) Incremental tax benefit--Extraordinary loss $10,500 Incremental tax benefit--Cumulative effect 4,600 Total tax benefit from losses $15,100

Tax benefit allocated to extraordinary loss [($10,500 i $15,100) x ($14,600)] $(10,152) Tax benefit allocated to cumulative effect [($4,600 i $15,100) x ($14,600)] (4,448) Total tax benefit allocated to all losses $(14,600) Problem 10 A major conceptual issue associated with interperiod tax allocation is the issue of discounting the deferred tax amount on the balance sheet to reflect its present value. Current generally accepted accounting principles do not allow the discounting of deferred taxes. Some in the profession have suggested, however, that the FASB should reconsider its position on discounting in light of the Boards current project on present value-based measurements in accounting. Provide arguments for and against the discounting of deferred income taxes. Solution 10 LO5 Proponents of discounting argue that without discounting the deferred tax asset or liability, the financial statements fail to indicate the appropriate benefit of the deferral of taxes or the burden of prepayment of taxes. Dollars related to short-term deferrals appear to have the same value on the financial statements as dollars related to longer term deferrals. This inconsistency impairs the comparability of the financial statements. Discounting would result in temporary differences that do not reverse until many years in the future being reflected at the present value of the expected future cash flows. The proponents argue that the discounting of deferred taxes is consistent with currently generally accepted accounting principles for long-term notes receivable and payable, pensions, and leases. Opponents of discounting argue that discounting results in a mismatching of the full tax effects of taxable transactions with the transactions themselves. The basic transaction that results in taxes occurs in one period, and the related tax effects are recorded in subsequent periods through the recording of interest on the deferred tax balance. Discounting also tends to conceal the consequences of transactions because they are hidden in the subsequent interest expense. Opponents further argue that deferred taxes are an interest free loan from the government thus eliminating the need for discounting. Problem 11 A major conceptual issue regarding the accounting for income taxes is the recognition of income taxes as expenses. Some would argue that income taxes are not directly related to revenues or revenue-seeking functions and should not be considered as expenses. Some view income taxes as a distribution of income similar to dividends. This view would hold that income taxes, like dividends, are paid only if income is earned. Wages and supplies, on the other hand, are paid for whether the entity earns a profit or incurs a loss.

Identify arguments that can be made for recognizing income tax as an expense on the income statement. Solution 11 LO5 Perhaps the strongest argument for recognizing income taxes as an expense rather than as a distribution is the fact that the government, like employees or suppliers, renders a service to the entity. The federal government does not provide services to an entity in direct proportion to the amount of tax levied, but it does provide services. Payment of corporate income tax allows an entity to conduct its business under favorable circumstances such as law, order, and the general organization of the economy. The federal government contributes to the orderly functioning of society that allows an enterprise to function and even prosper.