Chapter 16, Problem 16.4P

To determine

Temporary Difference

Temporary difference refers to the difference of one income recognized by the tax rules and accounting rules of a company in different periods. Consequently the difference between the amount of assets and liabilities reported in the financial reports and the amount of assets and liabilities as per the company’s tax records, is known as temporary difference.

Deferred Tax

Deferred tax is an amount i.e. computed on the basis of tax liability on the income as per income statement and the income as per tax return, that difference is known as deferred tax. Deferred tax amount is deferred to the next financial year.

Deferred tax asset

When the Income Tax Expense account is more than the Income Tax Payable account, this difference is known as Deferred Tax Asset.

Deferred tax liability

When the Income Tax Expense account is less than the Income Tax Payable account, this difference is known as Deferred Tax Liability.

To prepare: The journal entry to record the income taxes in 2016 assuming no difference between accounting and taxable income.

Explanation of Solution

The journal entry to record income taxes for 2016 is as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
2016	Income Tax Expense (9)		9,000
	Deferred Tax Liability (5)			2,880
	Income Tax Payable (1)			6,120
	(To record the income tax in 2016)

Table (1)

Compute income tax expense amount.

$\begin{array}{c}\text{Income tax expense=}\left(\text{Income tax payable +}\text{Deferred tax liability}\right)\\ \text{= \$6,120 + \$2,880}\\ \text{=\$9,000}\end{array}$ (9)

• Income Tax Expense is an expense account and it decreases the value of shareholders’ equity account. So, debit Income Tax Expense account with $9,000.
• Deferred tax liability is a liability and is increased by $2,880. Therefore, credit deferred tax liability account with $2,880.
• Income Tax Payable is a liability account has increased because the taxable income has increased. So, credit Income Tax Payable account with $6,120.

The journal entry to record income taxes for 2017 is as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
2017	Income Tax Expense (10)		18,240
	Deferred Tax Liability (6)			10,080
	Income Tax Payable (2)			8,160
	(To record the income tax in 2017)

Table (2)

Compute income tax expense amount.

$\begin{array}{c}\text{Income tax expense=}\left(\text{Income tax payable +}\text{Deferred tax liability}\right)\\ \text{= \$8,160 + \$10,080}\\ \text{=\$18,240}\end{array}$ (10)

• Income Tax Expense is an expense account and it decreases the value of shareholders’ equity account. So, debit Income Tax Expense account with $18,240.
• Deferred tax liability is a liability and is increased by $10,080 million. Therefore, credit deferred tax liability account with $10,080.
• Income Tax Payable is a liability account has increased because the taxable income has increased. So, credit Income Tax Payable account with $8,160.

The journal entry to record income taxes for 2018 is as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
2018	Income Tax Expense (11)		16,000
	Deferred Tax Liability (7)		4,800
	Income Tax Payable (3)			20,800
	(To record the income tax in 2018)

Table (3)

Compute income tax expense amount.

$\begin{array}{c}\text{Income tax expense=}\left(\text{Income tax payable -}\text{Deferred tax liability}\right)\\ \text{= \$20,800 - \$4,800}\\ \text{=\$16,000}\end{array}$ (11)

• Income Tax Expense is an expense account and it decreases the value of shareholders’ equity account. So, debit Income Tax Expense account with $16,000.
• Deferred tax liability is a liability and is decreased by $4,800. Therefore, debit deferred tax liability account with $4,800.
• Income Tax Payable is a liability account has increased because the taxable income has increased. So, credit Income Tax Payable account with $20,800.

The journal entry to record income taxes for 2019 is as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
2019	Income Tax Expense (12)		16,000
	Deferred Tax Liability (8)		8,160
	Income Tax Payable (4)			24,160
	(To record the income tax in 2019)

Table (4)

Compute income tax expense amount.

$\begin{array}{c}\text{Income tax expense=}\left(\text{Income tax payable -}\text{Deferred tax liability}\right)\\ \text{= \$24,160 - \$8,160}\\ \text{=\$16,000}\end{array}$ (12)

• Income Tax Expense is an expense account and it decreases the value of shareholders’ equity account. So, debit Income Tax Expense account with $16,000.
• Deferred tax liability is a liability and is decreased by $8,160. Therefore, debit deferred tax liability account with $8,160.
• Income Tax Payable is a liability account has increased because the taxable income has increased. So, credit Income Tax Payable account with $24,160.

Working Notes:

The following table shows the taxable income and income tax payable for the year 2016 to 2019

	Current year	Future deductible amount
	2016	2017	2018	2019
Pretax accounting income	$60,000	$80,000	$70,000	$70,000
Less: Depreciation for tax	$(39,600)	$(52,800)	$(18,000)	$(9,600)
Taxable income (tax return)	$20,400	$27,200	$52,000	$60,400
Enacted tax rate	30%	30%	40%	40%
Income Tax Payable	$6,120(1)	$8,160(2)	$20,800(3)	$24,160(4)

Table (5)

Calculate the amount of temporary difference (Deferred tax liability) for the year 2016 to 2019.

	Current year	Future deductible amount			Cumulative Difference
	2016	2017	2018	2019
Straight line depreciation	$30,000	$30,000	$30,000	$30,000
Less: Depreciation for tax	$(39,600)	$(52,800)	$(18,000)	$(9,600)
Temporary difference	$(9,600)	$(22,800)	$12,000	$20,400
2016		$(22,800)	$12,000	$20,400	$9,600
2017			$12,000	$20,400	$32,400
2018				$20,400	$20,400
2019					$0

Table (6)

Calculate the amount of deferred tax liability to be (debited)/credited in the journal entry.

	Current year	Future deductible amount
	2016	2017	2018	2019
Cumulative difference	$9,600	$32,400	$20,400	$0
Enacted tax rate	30%	40%	40%	40%
Year-end balance	$2,880	$12,960	$8,160	$0
Less: Previous balance	$0	$(2,880)	$(12,960)	$(8,160)
(Debit)/credit deferred tax liability	$2,880(5)	$10,080(6)	$(4,800) (7)	$(8,160) (8)

Table (7)