Advanced Financial Accounting I

Chapter One

Accounting for Income tax

Fundamentals of Accounting for Income
tax
• Corporations use guidelines to report information to investors and
creditors (GAAP) .
• Corporations also must file income tax returns following the
guidelines developed by the Internal Revenue Service (IRS).

• Because of GAAP and tax regulations differ in a number of ways, a

company reports as tax expense will differ from the amount of taxes
payable to the IRS.
Financial statement Vs Tax reporting
 Pretax financial income Vs Taxable income
• Pretax financial income is a financial reporting term.
• It also is often referred to as income before taxes, income for financial reporting
purposes, or income for book purposes.

• Companies determine pretax financial income according to GAAP to provide useful

information to investors and creditors.

• Taxable income (income for tax purposes) is a tax accounting term.

• It indicates the amount used to compute income taxes payable.
• Companies determine taxable income according to the Internal Revenue Code (the tax
code).
 Illustration GAAP Vs Tax Reporting
1. CHELSEA INC. GAAP REPORTING

     
2017 2018 2019 Total
     
Revenues $130,000 $130,000 $130,000
Expenses 60,000   60,000   60,000    

Pretax financial income $ 70,000   $ 70,000   $ 70,000   $210,000

Income tax expense (40%) $ 28,000   $ 28,000   $ 28,000   $ 84,000

               
 • For tax purposes Chelsea reported the same expenses to the IRS in
each of the years. But, Chelsea reported different taxable revenues
(due to Receivables) of $100,000 in 2017, $150,000 in 2018, and
$140,000 in 2019.

2. CHELSEA INC. TAX REPORTING

       
2017 2018 2019 Total
       
Revenues $100,000 $150,000 $140,000
Expenses 60,000   60,000   60,000    

Taxable income $ 40,000   $ 90,000   $ 80,000   $210,000

Income taxes payable (40%) $ 16,000   $ 36,000   $ 32,000   $ 84,000

               
 Income tax expense Vs income tax payable
• For this example Income tax expense and income taxes payable
differed over the three years but were equal in total.

CHELSEA INC. INCOME TAX EXPENSE AND

INCOME TAXES PAYABLE

  2017   2018   2019   Total

Income tax expense $28,000   $28,000   $28,000   $84,000

Income taxes payable 16,000   36,000   32,000   84,000

Difference $12,000   $ (8,000)   $ (4,000)   $ –0–

               
• Differences b/n income tax expense and income taxes
payable in this example arise for a simple reason (treat
account receivable differently).
• For financial reporting, companies use the full accrual
method to report revenues.
• For tax purposes, they use a modified cash basis.
• As a result, pretax financial income of $70,000 and income
tax expense of $28,000 for each of the three years.
• However, taxable income fluctuates. For example, in 2017
taxable income is only $40,000, so Chelsea owes just $16,000
to the IRS that year.
• As the above Illustration indicates, $12,000 ($28,000 − $16,000)
difference between income tax expense and income taxes
payable in 2017 reflects taxes that will be paid in future periods.

• This $12,000 difference is often referred to as a deferred tax

amount.

• In this case, it is a deferred tax liability (future burden).

• In cases where taxes will be lower in the future, we record as

deferred tax asset (future benefit (tax save)).
Future Taxable Amounts and Deferred Taxes
A temporary difference is a difference between the tax basis and book
basis of assets and liabilities in the financial statements, which will result
in taxable amounts or deductible amounts in future years.

Taxable amounts increase taxable income in future years.

Deductible amounts decrease taxable income in future years.

In the previous example, the only difference between the book basis and
tax basis of the assets and liabilities relates to accounts receivable that
arose from revenue recognized for book purposes. The illustration
indicates that Chelsea reports account receivable at $30,000.

Per Books 12/31/17 Per Tax Return 12/31/17

Accounts receivable $30,000 Accounts receivable $–0–

compiled by: Ashu G.
What will happen to the $30,000 temporary difference
that originated in 2017 for Chelsea?

Assuming Chelsea expects to collect $20,000 in 2018

and $10,000 in 2019, this collection results in future
taxable amounts of $20,000 in 2018 and $10,000 in
2019. These will cause taxable income exceed pretax
financial income.
• That is, companies recognize income taxes that are
payable when they recover the reported assets.
• Recognize the amount of income taxes that are
refundable when they settle liabilities.
compiled by: Ashu G.
Reversal of Temporary Difference

compiled by: Ashu G.

 Deferred Tax Liability
A deferred tax liability represents the increase in taxes payable in future
years as a result of taxable temporary differences existing at the end of the
current year.
Based on Example, income taxes payable is $16,000 ($40,000 × 40%) in
2017. In addition, a temporary difference exists at year-end b/c revenue
and related A/R differently for book and tax purposes.
The book basis of A/R is $30,000, and the tax basis is zero. Thus, the total
deferred tax liability at the end of 2017 is $12,000.
Book basis of accounts receivable $30,000
Tax basis of accounts receivable –0–
Cumulative temporary difference at the end of 2017 30,000
Tax rate 40%
Deferred tax liability at the end of 2017 $12,000
compiled by: Ashu G.
Because it is the first year of operations for Chelsea, there is no deferred
tax liability at the beginning of the year. Income tax expense for 2017
will be.

Deferred tax liability at end of 2017 $12,000

Deferred tax liability at beginning of 2017 –0–

Deferred tax expense for 2017 12,000

Current tax expense for 2017 (income taxes payable) 16,000

Income tax expense (total) for 2017 $28,000

compiled by: Ashu G.

• This computation indicates that income tax expense has two components
current tax expense & deferred tax expense.
• Deferred tax expense is the increase in the deferred tax liability balance from
the beginning to the end of the accounting period.

For Chelsea, it makes the following entry at the end of 2017.

Income Tax Expense 28,000

Income Taxes Payable 16,000
Deferred Tax Liability 12,000

compiled by: Ashu G.

• At the end of 2018 (2nd year), the d/c b/n the book basis and the tax basis of the A/R is
$10,000. Chelsea’s deferred tax liability is $4,000 ($10,000 × 40%), which it reports at
the end of 2018. Income taxes payable for 2018 is $36,000 and the income tax expense
for 2018 is $28,000.

Deferred tax liability at end of 2018 $ 4,000

Deferred tax liability at beginning of 2018 12,000
Deferred tax expense (benefit) for 2018 (8,000)
Current tax expense for 2018 (income taxes payable) 36,000

Income tax expense (total) for 2018 $28,000

Income Tax Expense 28,000

Deferred Tax Liability 8,000
Income Taxes Payable 36,000
compiled by: Ashu G.
• At the end of 2019 (3rd and final year), the d/ce b/n the book basis and the tax basis of
the A/R is zero. Income taxes payable for 2019 is $32,000 and the income tax expense
for 2019 is $28,000.

Income Tax Expense 28,000

Deferred Tax Liability 4,000
Income Taxes Payable 32,000
compiled by: Ashu G.
Financial Statement Effects
For the Balance Sheet income taxes payable will be reported as
current liability, and the deferred tax liability is reported as a
noncurrent liability.

Year-End   Income Taxes Payable   Deferred Tax Liability

2017   $16,000   $12,000
2018 36,000 4,000
2019 32,000

compiled by: Ashu G.

For Income Statement, Income Tax Expense will be
Presented totally or separately as current tax and differed tax.

For the Year Ended 2017 2018 2019

Income before income taxes $70,000 $70,000 $70,000
Income tax expense 28,000 28,000 28,000
Net income $42,000 $42,000 $42,000

compiled by: Ashu G.

 Future Deductible Amounts and Deferred Taxes
Deductible amounts decrease taxable income in future years.
Assume that during 2017, Cunningham Inc. estimated its warranty costs
related to the sale of microwave ovens to be $500,000, paid evenly over
the next two years.
For book purposes, Cunningham reported warranty expense and a
related estimated liability for warranties of $500,000.
For tax purposes, the warranty tax deduction is not allowed until paid.

compiled by: Ashu G.

When Cunningham pays the warranty liability, it reports an
expense (deductible amount) for tax purposes.
Because of this temporary difference, should recognize in 2017 the
tax benefits (positive tax consequences) for the tax deductions that
will result from the future settlement of the liability.

Cunningham reports this future tax benefit in the Dec 31, 2017,
balance sheet as a deferred tax asset.

Deductible amounts occur in future tax returns. These future

deductible amounts cause taxable income to be less than pretax
financial income in the future as a result of an existing temporary
difference. compiled by: Ashu G.
Cunningham’s temporary difference originates
(arises) in one period (2017) and reverses over the
future two periods (2018 and 2019).

compiled by: Ashu G.

 Deferred Tax Asset
•A deferred tax asset represents the increase in taxes refundable (or
saved) in future years as a result of deductible temporary differences
existing at the end of the current year.

To illustrate, assume that Hunt Company has revenues of $900,000

for both 2017 and 2018. It also has operating expenses of $400,000 for
each of these years. In addition, Hunt accrues a loss and related
liability of $50,000 for financial reporting purposes because of
pending litigation.

Hunt cannot deduct this amount for tax purposes until it pays the
liability, expected in 2018. As a result, a deductible amount will
occur in 2018 when Hunt settles the liability, causing taxable income
to be lower than pretax financial information.
compiled by: Ashu G.
  GAAP Reporting      
    2017   2018
Revenues   $900,000  $900,000
Expenses (operating)   400,000  400,000
Litigation loss   50,000  −0−
Pretax financial income   $450,000  $500,000
Tax rate   40%  40%
Income tax expense   $180,000  $200,000
         
  Tax Reporting      
  Revenues   2017   2018
  $900,000  $900,000
Expenses (operating)
  400,000  400,000
Litigation loss     50,000
Taxable income   $500,000  $450,000
Tax rate   40%  40%
Income taxes payable   compiled by: Ashu G.
$200,000  $180,000
• In this case, Hunt records a deferred tax asset of $20,000 at
the end of 2017 because it represents taxes that will be saved
in future periods.
• Computation of the deferred tax asset at the end of 2017
(assuming a 40% tax rate) will be.

Book basis of litigation liability $50,000

Tax basis of litigation liability –0–
Cumulative temporary difference at the end of 2017 50,000
Tax rate 40%
Deferred tax asset at the end of 2017 $20,000

compiled by: Ashu G.

• Assuming that 2017 is Hunt’s first year of operations and
income taxes payable is $200,000, Hunt computes its income
tax expense as follows.

Deferred tax asset at end of 2017 $ 20,000

Deferred tax asset at beginning of 2017 –0–
Deferred tax benefit (Save) for 2017 (20,000)
Current tax expense for 2017 (income taxes payable) 200,000
Income tax expense (total) for 2017 $180,000

compiled by: Ashu G.

• The deferred tax benefit results from the increase in the
deferred tax asset from the beginning to the end of the
accounting period. The deferred tax benefit is a negative
component of income tax expense.
• The total income tax expense of $180,000 on the income
statement for 2017 thus consists of two elements—current tax
expense of $200,000 and a deferred tax benefit of $20,000.
• Hunt makes the following journal entry.

 
Income Tax Expense 180,000
Deferred Tax Asset 20,000  
Income Taxes Payable 200,000
 
compiled by: Ashu G.
 Income tax expense for 2018

Deferred tax asset at the end of 2018 $ –0–

Deferred tax asset at the beginning of 2018 20,000
Deferred tax benefit (Save) for 2018 20,000
Current tax expense for 2018 (income taxes payable)
180,000
Income tax expense (total) for 2018
$200,000

compiled by: Ashu G.

The company records income taxes for 2018 as follows.

Income Tax Expense 200,000

Deferred Tax Asset 20,000
Income Taxes Payable 180,000

• The total income tax expense of $200,000 on the income statement for
2018 thus consists of two elements.
current tax expense of $180,000 and
deferred tax expense of $20,000.
compiled by: Ashu G.
Financial Statement Effects
For Balance Sheet Hunt Company reports the following
information on its balance sheets for 2017 and 2018 as shown in
Illustration.

• Income taxes payable is reported as a current liability, and the

deferred tax asset is reported as a noncurrent asset.
compiled by: Ashu G.
 For Income statement; On its income statement, Hunt
Company reports the information as shown in Illustration.

HUNT COMPANY INCOME STATEMENT

FOR THE YEAR ENDING DECEMBER 31, 2017

Revenues     $900,000
Expenses (operating) 400,000
   
Litigation loss     50,000
Income before income taxes     450,000
Income tax expense  
Current $200,000
Deferred (20,000)  180,000
Net income     $270,000
       
compiled by: Ashu G.
 Temporary Vs Permanent Differences
1. Temporary Difference

• Taxable temporary differences are differences that will result in taxable

amounts in future years when the related assets are recovered.

• Taxable temporary differences give rise to recording deferred tax liabilities.

• Deductible temporary differences are differences that will result in

deductible amounts in future years when the related book liabilities are
settled.

• Deductible temporary differences give rise to recording deferred tax assets.

compiled by: Ashu G.

Temporary Difference …………Cont;d
• Determining a company’s temporary differences may prove
difficult. A company should prepare a balance sheet for tax
purposes that it can compare with its GAAP balance sheet. Many of
the differences between the two balance sheets are temporary
differences.
Originating and Reversing Temporary Differences.
• An originating temporary difference is the initial difference
between the book basis and the tax basis of an asset or liability,
regardless of whether the tax basis of the asset or liability exceeds or
is exceeded by the book basis of the asset or liability.
• A reversing difference, on the other hand, occurs when eliminating
a temporary difference that originated in prior periods and then
removing the related tax effect from the deferred tax account.
compiled by: Ashu G.
 2. Permanent differences
 Permanent differences result from items that (1) enter into pretax financial
income but never into taxable income, and vise versa.

 Congress has enacted a variety of tax law provisions to attain certain

political, economic, and social objectives.

 Some of these provisions exclude certain revenues from taxation, limit the
deductibility of certain expenses, and permit the deduction of certain other
expenses in excess of costs incurred.
• Since permanent differences affect only the period in which they occur, they
do not give rise to future taxable or deductible amounts.
• As a result, companies recognize no deferred tax consequences.
compiled by: Ashu G.
 Examples of Permanent Differences
Items recognized for financial reporting purposes but not for tax purposes.

1. Interest received on state and municipal obligations.

2. Expenses incurred in obtaining tax-exempt income.
3. Proceeds from (Premiums paid for) life insurance carried by the
company on key officers or employees.
4. Fines and expenses resulting from a violation of law.
Items recognized for tax purposes but not for financial reporting purposes.

5. “Percentage depletion” of natural resources in excess of their cost.

6. The deduction for dividends received from U.S. corporations.

compiled by: Ashu G.

 Illustrations of Temporary and Permanent Differences

• Assume that Bio-Tech Company reports pretax financial income of

$200,000 in each of the years 2015,16, and 17. The company is subject to
a 30% tax rate and has the following differences between pretax financial
income and taxable income.

1. It pays life insurance premiums for its key officers of $5,000 in 2016
and 2017. Although not tax-deductible, Bio-Tech expenses the
premiums for book purposes.

2. Bio-Tech reports gross profit of $18,000 from an installment sale in

2015 for tax purposes over an 18-month period at a constant amount
per month beginning January 1, 2016. It recognizes the entire amount
for book purposes in 2015.
compiled by: Ashu G.
• The installment sale is a temporary difference, whereas
the life insurance premium is a permanent difference.
     
2015 2016 2017
Pretax financial income $200,000   $200,000  $200,000
Permanent Difference
(Non-deductible expense ) 5,000 5,000
        
Temporary difference
(Installment sale) (18,000) 12,000 6,000
Taxable income 182,000   217,000  211,000

Tax rate 30%   30%   30%

Income taxes payable $ 54,600   $ 65,100  $ 63,300

compiled by: Ashu G.

 Interpretation
Bio-Tech deducts the installment-sales gross profit from pretax
financial income to arrive at taxable income Because Pretax
financial income includes the installment-sales gross profit;
taxable income does not.
Conversely, it adds the $5,000 insurance premium to pretax
financial income to arrive at taxable income Because Pretax
financial income records an expense for this premium, but not for
tax purposes.

Therefore, the life insurance premium must be added back to

pretax financial income to reconcile to taxable income.

compiled by: Ashu G.

 
 
December 31, 2015

  Income Tax Expense ($54,600 + $5,400) 60,000  

5,400
Deferred Tax Liability ($18,000 × 30%)

  Income Taxes Payable ($182,000 × 30%)   54,600

December 31, 2016

Income Tax Expense ($65,100 – $3,600) 61,500  

Deferred Tax Liability ($12,000 × 30%) 3,600  

65,100
Income Taxes Payable ($217,000 × 30%)
December 31, 2017

Income Tax Expense ($63,300 – $1,800) 61,500  

Deferred Tax Liability ($6,000 × 30%) 1,800  

63,300
Income Taxes Payable ($211,000 × 30%)
compiled by: Ashu G.
Bio-Tech has one temporary difference, which originates in 2015 and
reverses in 2016 and 2017. As the temporary difference reverses, Bio-Tech
reduces the deferred tax liability.

There is no deferred tax amount associated with the difference caused by the
nondeductible insurance expense because it is a permanent difference.

Although an enacted tax rate of 30% applies for all three years, the effective
rate differs from the enacted rate in 2016 and 2017. Bio-Tech computes the
effective tax rate by dividing total income tax expense for the period by
pretax financial income.

The effective rate is 30% for 2015 ($60,000 ÷ $200,000 = 30%) and 30.75%
for 2016 and 2017 ($61,500 ÷ $200,000).

compiled by: Ashu G.

 Revision of Future Tax Rates
When a change in the tax rate is enacted, companies should record its
effect on the existing deferred income tax accounts immediately. A
company reports the effect as an adjustment to income tax expense in the
period of the change.

Assume that on December 10, 2017, a new income tax act is signed into
law that lowers the corporate tax rate from 40%to 35%, effective January
1, 2019. If Hostel Co. has one temporary difference at the beginning of
2017 related to $3 million of excess tax depreciation, then it has a
Deferred Tax Liability account with a balance of $1,200,000 ($3,000,000 ×
40%) at January 1, 2017. If taxable amounts related to this difference are
scheduled to occur equally in 2018, 2019, and 2020, the deferred tax
liability at the end of 2017 is $1,100,000, computed as follows.

compiled by: Ashu G.

   2018   2019   2020   Total
Future taxable amounts $1,000,000   $1,000,000   $1,000,000   $3,000,000
Tax rate 40%   35%   35%   
Deferred tax liability $ 400,000   $ 350,000   $ 350,000   $1,100,000
         
               

.
Hostel, therefore, recognizes the decrease of $100,000 ($1,200,000 – $1,100,000) at the end of
2017 in the deferred tax liability as follows.

Deferred Tax Liability100,000

Income Tax Expense 100,000

• Corporate tax rates do not change often. Therefore, companies usually employ the
current rate. However, state and foreign tax rates change more frequently, and they
require adjustments in deferred income taxes accordingly.
compiled by: Ashu G.
ACCOUNTING FOR NET OPERATING LOSSES
• Net operating loss (NOL) occurs for tax purposes, when tax-
deductible expenses exceed taxable revenues.
• For an established company, a major event such as a labor
strike, rapidly changing regulatory and competitive forces, a
disaster such as 9/11, or a general economic recession can cause
expenses exceed revenues—a net operating loss.
• Inequitable tax burden would result if companies were
taxed during profitable periods without receiving any tax
relief during periods of net operating losses.
• Companies accomplish this income-averaging provision (losses
of one year to offset the profits of other years) through the
carryback and carryforward of net operating losses.
compiled by: Ashu G.
 Loss Carryback
• CARRYBACKS. Deductions or credits that cannot be utilized on the tax
return during a year and that may be carried back to reduce taxable
income or taxes paid in a prior year.
• Through use of a loss carryback, a company may carry the net operating
loss back two years and receive refunds for income taxes paid in those
years.
• The company must apply the loss to the earlier year first and then to the
second year.

compiled by: Ashu G.

 Example
• To illustrate the accounting procedures for a net operating loss carryback,
assume that Groh Inc. has no temporary or permanent differences.
Year   Taxable Income or Loss    Tax Rate    Tax Paid
2014   $ 50,000   35%   $17,500
2015   100,000   30%   30,000
2016   200,000   40%   80,000
2017   (500,000)   —   –0–

• In 2017, Groh incurs a net operating loss that it decides to carry back.
• Groh Inc must carries the loss back first to 2015. Then, Groh carries back
any unused loss to 2016.
• Accordingly, Groh files amended tax returns for 2015 and 2016, receiving
refunds for the $110,000 ($30,000 + $80,000) of taxes paid in those years.

compiled by: Ashu G.

 For accounting as well as tax purposes, the $110,000 represents the tax effect
(tax benefit) of the loss carryback. Groh should recognize this tax effect in 2017,
the loss year.

Income Tax Refund Receivable 110,000

Benefit Due to Loss Carryback (Income Tax Expense) 110,000

• Groh reports the account debited, Income Tax Refund Receivable, on the
balance sheet as a current asset at December 31, 2017. It reports the account
credited on the income statement for 2017.

• Since the $500,000 net operating loss for 2017 exceeds the $300,000 total
taxable income from the 2 preceding years, Groh carries forward the
remaining $200,000 loss.
compiled by: Ashu G.
 Loss carryforwards
• CARRYFORWARDS. Deductions or credits that cannot be utilized on the
tax return during a year and that may be carried forward to reduce
taxable income or taxes payable in a future year
• If a carryback fails to fully absorb a net operating loss or if the company
decides not to carry the loss back, then it can carry forward. Because
companies use carryforwards to offset future taxable income, the tax effect
of a loss carryforward represents future tax savings.

compiled by: Ashu G.

 Example
Return to the Groh example In 2017, the company records the tax
effect of the $200,000 loss carryforward as a deferred tax asset of
$80,000 ($200,000 × 40%), assuming that the enacted future tax
rate is 40%. Groh records the benefits of the carryback and the
carryforward in 2017 as follows.

compiled by: Ashu G.

• Groh realizes the income tax refund receivable of $110,000
immediately as a refund of taxes paid in the past. It establishes
a Deferred Tax Asset account for the benefits of future tax
savings.
• The two accounts credited are contra income tax expense items,
which Groh presents on the 2017 income statement .
• The current tax benefit of $110,000 is the income tax refundable
for the year.
• The $80,000 is the deferred tax benefit for the year, which
results from an increase in the deferred tax asset

compiled by: Ashu G.

 Computation of Income Taxes Payable with Realized Loss Carryforward

• For 2018, assume that Groh returns to profitable operations and

has taxable income of $250,000 (prior to adjustment for the NOL
carryforward), subject to a 40% tax rate. Groh then realizes the
benefits of the carryforward for tax purposes in 2018, which it
recognized for accounting purposes in 2017. Groh computes the
income taxes payable for 2018.

Taxable income prior to loss carryforward $ 250,000

Loss carryforward deduction (200,000)
Taxable income for 2018 50,000
Tax rate 40%
Income taxes payable for 2018 $ 20,000
compiled by: Ashu G.
• Groh records income taxes in 2018 as follows.

Income Tax Expense 100,000  

Deferred Tax Asset   80,000

Income Taxes Payable   20,000

• The benefits of the NOL carryforward, realized in 2018, reduce

the Deferred Tax Asset account to zero.

compiled by: Ashu G.

 Carryforward with Valuation Allowance

VALUATION ALLOWANCE. The portion of a deferred tax asset for which

it is more likely than not that a company will not realize a tax benefit.
• Assume that it is more likely than not that Groh will not realize
the entire NOL carryforward in future years.
• In this situation, Groh records the tax benefits of $110,000
associated with the $300,000 NOL carryback, as we previously
described.
• In addition, it records Deferred Tax Asset of $80,000 ($200,000 ×
40%) for the potential benefits related to the loss carryforward,
and an allowance to reduce the deferred tax asset by the same
amount

compiled by: Ashu G.

 FINANCIAL STATEMENT PRESENTATION
1. Balance Sheet
• Income taxes payable and income tax refund receivable are
reported as a current liability and current asset, respectively, on
the balance sheet.

• Deferred tax assets and deferred tax liabilities are separately

recognized and measured and then offset on the balance sheet.

• The net deferred tax asset or net deferred tax liability is therefore
reported in the noncurrent section of the balance sheet.

compiled by: Ashu G.

 Income Statement
• Companies are required to report income before taxes and
income tax expense on the income statement.
• Income tax expense generally equals the sum of income taxes
payable and the change in the deferred tax expense.
• Income tax benefit generally equals the sum of income taxes
refundable and the change in the deferred tax benefit.

• For example, a company adds an increase in a deferred tax

liability to income taxes payable. On the other hand, it subtracts
an increase in a deferred tax asset from income taxes payable.

compiled by: Ashu G.

Summary

compiled by: Ashu G.

EXAMPLE NSIVE Comprehensive example
• Allman Company, which began operations at the beginning of
2016, produces various products on a contract basis.
• Each contract generates a gross profit of $80,000. Some of
contracts provide for the customer on an installment basis.
• Under these contracts, Allman collects one-fifth (20%) of the
contract revenue in each of the following four years.
• For financial reporting purposes, the company uses accrual
basis and for tax purposes, Allman uses installment basis (cash
basis ).

compiled by: Ashu G.

 Information related to Allman’s operations for
2016 are given below.
1. In 2016, the company completed seven (7) contracts that allow for the
customer to pay on an installment basis. Allman recognized the related
gross profit of $560,000 (7 x 80,000) for financial reporting purposes. It
reported only $112,000 (20% x 560,000) of gross profit on installment sales
on the 2016 tax return. The company expects future collections on the
related installment receivables to result in taxable amounts of $112,000 in
each of the next four years.

2. At the beginning of 2016, Allman Company purchased depreciable assets

with a cost of $540,000. For book purposes, Asset depreciates using the
SLM over 6 yrs. For tax purposes, the assets fall in the five-year recovery
class, and Allman uses the MACRS system.
compiled by: Ashu G.
 Depreciation computation

 Year   Depreciation for Book Purposes   Depreciation for Tax Purposes    Difference
2016   $ 90,000   $108,000   $(18,000)
2017  
90,000  
172,800  
(82,800)

2018 90,000 103,680 (13,680)

     
2019  
90,000  
62,208  
27,792

2020  
90,000  
62,208  
27,792

2021   90,000   31,104   58,896

    $540,000   $540,000   $ –0–

compiled by: Ashu G.

1.During 2016, the product warranty liability accrued for book
purposes was $200,000, and the actual paid for warranty liability
was $44,000. Allman expects to settle the remaining $156,000 by
expenditures of $56,000 in 2017 and $100,000 in 2018.
2.In 2016, nontaxable municipal bond interest revenue was
$28,000.
3.In 2016, nondeductible fines and penalties of $26,000 were paid.
4.Pretax financial income for 2016 amounts to $412,000.
5.Tax rates enacted up to 2016 were 50% and for 2017 and later
years 40%.
compiled by: Ashu G.
 Required
1. Identify temporary and permanent differences?
2. Determine taxable income of 2016?
3. Computes income taxes payable for 2016?
4. Compute future taxable amount (DTL) at the end of 2016?
5. Compute future deductible amount (DTA) at the end of 2016?
6. Compute net deferred tax expense (DTL - DTA) for 2016?
7. Compute total income tax expense (deferred + current) of 2016?
8. Records income taxes payable, deferred income taxes, and income tax expense
of 2016?
9. Show the financial presentation.
compiled by: Ashu G.
 Solution

Do it!
compiled by: Ashu G.