Chapter 18, Problem 4P

Interperiod Tax Allocation Klerk Company had four temporary differences between its pretax financial income and its taxable income during 2019 as follows:

At the beginning of 2019, Klerk had a deferred tax liability of $84,300 related to Temporary Difference #2 and a deferred tax asset of $21,090 related to Temporary Difference #4. Based on its tax records, Klerk earned taxable income of $270,000 for 2019. Kerk’s accountant has prepared the following schedule showing the total future taxable and deductible amounts at the end of 2019 for its four temporary differences:

The company has a history of earning income and expects to be profitable in the future. The income tax rate for 2019 is 40%, but in 2018 Congress enacted a 30% tax rate for 2020 and future years.

During 2019, for financial accounting purposes, Klerk reported revenues of $750,000 and expenses of $447,100. The deferred taxes related to Temporary Differences #1, #2, and #4 are considered to be noncurrent by the company; the deferred tax related to Temporary Difference #3 is considered to be current.

Required:

1. 1. Prepare Klerk’s income tax journal entry for 2019.
2. 2. Prepare a condensed 2019 income statement for Klerk.
3. 3. Show how the income tax items are reported on Klerk’s December 31, 2019, balance sheet.

To determine

Prepare journal to record the entry for income tax of Company K at the end of 2019.

Explanation of Solution

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.

Prepare journal to record the entry for income tax of Company K at the end of 2019:

Date	Account title and Explanation	Post ref.	Amount
			Debit	Credit
2019
December 31	Income tax expense (balancing figure)		$117,870
	Deferred tax asset (1)		$6,000
	Deferred tax liability (2)		$12,000
	Income tax payable (3)			$108,000
	Deferred tax liability (4)			$23,370
	Deferred tax asset (5)			$4,500
	(To record the income tax payable)

Table (1)

• Income Tax Expense is a component of stockholders’ equity and decreases, so debt it for $117,870.
• Deferred Tax Asset is an asset and increases, so debit it for $6,000.
• Deferred Tax Liability is a liability and decreases, so debit it for $12,000.
• Income Tax Payable is a liability and increases, so credit it for $108,000.
• Deferred Tax Liability is a liability and increases, so credit it for $23,370.
• Deferred Tax Asset is an asset and decreases, so credit it for $4,500.

Working note 1: Determine the deferred tax asset:

$\begin{array}{c}\text{Deferred tax asset}=\text{Future deductible amount}\times \text{Applicable tax rate}\\ \text{=\$20,000}\times 30\text{\%}\\ \text{=\$6,000}\end{array}$

Working note 2: Determine the Deferred tax liability:

$\begin{array}{c}\text{Deferred tax liability}=\left[\left(\begin{array}{l}\text{Future taxable}\\ \text{ amount}\end{array}\right)\times \left(\begin{array}{l}\text{Applicable }\\ \text{tax rate}\end{array}\right)\right]-\left(\begin{array}{l}\text{Beginning deferred}\\ \text{ tax liability}\end{array}\right)\\ \text{=}\left(\text{\$241,000}\times 30\text{\%}\right)-\$84,300\\ =\$72,300-\$84,300\\ \text{=}\left(\text{\$12,000}\right)\end{array}$

Working note 3: Determine the income tax payable:

$\begin{array}{c}\text{Income tax payable}=\text{Taxable income}\times \text{Corporate tax rate}\\ \text{=\$270,000}\times 40\text{\%}\\ \text{=\$108,000}\end{array}$

Working note 4: Determine the deferred tax liability:

$\begin{array}{c}\text{Deferred tax liability}=\text{Future taxable amount}\times \text{Applicable tax rate}\\ \text{=\$77,900}\times 30\text{\%}\\ \text{=\$23,370}\end{array}$

Working note 5: Determine the deferred tax asset:

$\begin{array}{c}\text{Deferred tax asset}=\left[\left(\begin{array}{l}\text{Future deductible}\\ \text{ amount}\end{array}\right)\times \left(\begin{array}{l}\text{Applicable }\\ \text{tax rate}\end{array}\right)\right]-\left(\begin{array}{l}\text{Beginning deferred}\\ \text{ tax asset}\end{array}\right)\\ \text{=}\left(\text{\$55,300}\times 30\text{\%}\right)-\$21,090\\ =\$16,590-\$21,090\\ \text{=}\left(\text{\$4,500}\right)\end{array}$

To determine

Prepare the condensed income statement of Company K.

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 the condensed income statement of Company K.

Particulars	Amount
Revenues	$750,000
Less: Expenses	($447,100)
Income before income taxes	$302,900
Income tax expense	($117,870)
Net income	$185,030

Table (2)

Thus, the net income of Company K is $185,030.

To determine

Explain the manner of reporting income tax items in the balance sheet of Company K.

Explanation of Solution

Balance sheet: Balance Sheet is one of the financial statements that summarize the assets, the liabilities, and the Shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

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

Company K
Balance sheet (partial)
As on December 31, 2019
Assets	Amount
Total assets
Liabilities
Current liabilities:
Income tax payable	$108,000
Non- Current liabilities:
Deferred tax liability (6)	$73,080
Total liabilities	$181,080

Table (3)

Thus, the total liabilities as on December 31, 2019 for Company K are $181,080.

Working Note 6: Determine the net deferred tax liability reported in balance sheet:

$\begin{array}{c}\text{Deferred Tax Liability= }\left[\left(\$77,900\times 30\%\right)+\left(\$241,000\times 30\%\right)-\left\{\begin{array}{l}\left(\$55,300\times 30\%\right)\\ -\$6,000\end{array}\right\}\right]\\ =\text{ \$79,080}\end{array}$