Chapter 18, Problem 12P

Comprehensive Colt Company reports pretax financial “income” of $143,000 in 2019. In addition to pretax income from continuing operations (of which revenues are $295,000), the following items are included in this pretax “income:”

Colt’s taxable income totals $93,000 in 2019. The difference between the pretax financial income and the taxable income is due to the excess of tax depreciation over financial depreciation on assets used in continuing operations.

At the beginning of 2019, Colt had a retained earnings balance of $310.000 and a deferred tax liability of $8,100. During 2019, Colt declared and paid dividends of $48,000. It is subject to tax rates of 15% on the first $50,000 of income and 30% on income in excess of $50,000. Based on proper interperiod tax allocation procedures, Colt has determined that its 2019 ending deferred tax liability is $14,100.

Required:

1. 1. Prepare a schedule for Colt to allocate the total 2019 income tax expense to the various components of pretax income.
2. 2. Prepare Colt’s income tax journal entry at the end of 2019.
3. 3. Prepare Colt’s 2019 income statement.
4. 4. Prepare Colt’s 2019 statement of retained earnings.
5. 5. Show the related income tax disclosures on Colt’s December 31, 2019, balance sheet.

To determine

Prepare a schedule to distribute the income tax expense to the components of pre-tax income.

Explanation of Solution

Prepare a schedule to distribute the income tax expense to the components of pre-tax income:

Company C
Schedule of Income Tax Expense
For the Year Ended December 31, 2019
Component of Income (pre-tax)	Amount	$\begin{array}{c}\times \end{array}$	Tax rate	$=$	Income Tax expense
Income from continuing operations (1)	$50,000	$\begin{array}{c}\times \end{array}$	15%	$=$	$7,500
	$65,000	$\begin{array}{c}\times \end{array}$	30%	$=$	$19,500
Loss from disposal of Division B	($10,000)	$\begin{array}{c}\times \end{array}$	30%	$=$	($3,000)
Income from operation of discontinued Division B	$16,000	$\begin{array}{c}\times \end{array}$	30%	$=$	$4,800
Prior period adjustment	($8,000)	$\begin{array}{c}\times \end{array}$	30%	$=$	($2,400)
Total					$26,400

Table (1)

Working note 1: Determine the pre-tax income from continuing operations:

Particulars	Amount	Amount
Total pre-tax accounting income		$143,000
Less: Income from operation of discontinued Division B		($16,000)
		$127,000
Add: Loss from disposal of Division B		$10,000
Prior period adjustment		$8,000
Pre-tax income from continuing operations		$145,000

Table (2)

To determine

Record the income tax entry for Company C.

Explanation of Solution

Income Tax Expenses: The expenses which are related to the taxable income of the individuals and business entities for an accounting period, and are recognized by them for the purpose of federal government and state government tax are called as income tax expenses.

Record the income tax entry for Company C.

Date	Accounts title and explanation	Post Ref.	Debit ($)	Credit ($)
December 31, 2019	Income Tax Expense (Refer table (1))		27,000
	Income from discontinued division  B		4,800
	Loss from Disposal of Division B			3,000
	Retained Earnings(prior period adjustment)			2,400
	Deferred Tax Liability (2)			6,000
	Income Tax Payable (3)			20,400
	(To record income tax expense with pretax income allocation)

Table (3)

• Income Tax Expense is a component of stockholders’ equity and decreased, so debit it for $27,000.
• Income from discontinued division B is a component of stockholders’ equity and decreased, so debit it for $4,800.
• Loss from disposal of division B is a component of stockholders’ equity and increased, so credit it for $3,000.
• Retained Earnings is a component of stockholders’ equity and increased, so credit it for $2,400.
• Deferred Tax Liability is a liability and increased, so credit it for $6,000.
• Income Tax Payable is a liability and increased, so credit it for $20,400.

Working note 2: Compute the deferred tax liability:

$\begin{array}{c}\text{Deferred tax liability}=\left(\begin{array}{l}\text{Ending deferred}\\ \text{ tax liability}\end{array}\right)-\left(\begin{array}{l}\text{Deferred deferred}\\ \text{ tax liability}\end{array}\right)\\ =\$14,100-\$8,100\\ \text{=\$6,000}\end{array}$

Working note 3: Compute the income tax payable:

$\begin{array}{c}\text{Income tax payable}=\text{Taxable income}\times \text{Corporate tax rate}\\ =\left(\$50,000\times 15\%\right)+\left(\$43,000\times 30\%\right)\\ =\$7,500+\$12,900\\ \text{=\$20,400}\end{array}$

To determine

Prepare an income statement of Company C for the year 2019.

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Prepare an income statement of Company C for the year 2019:

Company C
Income statement
For the year ended December 31, 2019
Particulars	Amount	Amount
Revenues		$295,000
Less: Expenses $\left(\$295,000-\$145,000\right)$		($150,000)
Pre-tax income from continuing operations		$145,000
Less: Income tax expense		($27,000)
Income from continuing operations		$118,000
Results from discontinued operations:
Income from disposal of discontinued Division F (net of $4,800 income taxes)	$11,200
Loss from operation of discontinued Division F (net of $3,000 income tax credit)	($7,000)	$4,200
Net income		$122,200

Table (4)

Thus, the net income of Company C is $122,200.

To determine

Prepare statement of retained earnings of Company C for 2019.

Explanation of Solution

Statement of Retained Earnings: Statement of retained earnings shows, the changes in the retained earnings, and the income left in the company after payment of the dividends, for the accounting period.

Prepare the statement of retained earnings:

Company C
Statement of Retained Earnings
For the year ended December 31, 2019
Particulars	Amount
Retained earnings, January 1, 2019	$310,000
Less: Prior period adjustment (net of $2,400 income taxes)	($5,600)
Adjusted retained earnings, January 1, 2019	$304,400
Add: Net income	$122,200
	$426,600
Less: Cash dividends	($48,000)
Retained Earnings, December 31, 2019	$378,600

Table (5)

Thus, the ending retained earnings for the year ended December 31 is $378,600.

To determine

Explain the manner of reporting income tax disclosures in the balance sheet of Company C.

Explanation of Solution

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

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

Prepare balance sheet of Company C as on December 31, 2019:

Company C
Balance sheet (partial)
As on December 31, 2019
Assets	Amount
Current liabilities:
Income taxes payable	$20,400
Non- Current liabilities:
Deferred tax liability	$14,100
Total liabilities	$34,500

Table (6)

Thus, the total liabilities as on December 31, 2019 for Company C are $34,500.