Chapter 18, Problem 8P

Deferred Tax Liability: Depreciation Gire Company began operations at the beginning of 2019 at which time it purchased a depreciable asset for $60, 000. For 2019 through 2022, the asset was depreciated on the straight-line basis over a 4-year life (no residual value) for financial reporting. For income tax purposes, the asset was depreciated using MACRS (200%, 3-year life).

For 2019 through 2022, Gire reported pretax financial income and taxable income of the following amounts (the differences are due solely to the depreciation temporary differences):

Over the entire 4-year period, Gire was subject to an income tax of 30%, and no change in the tax rate had been enacted for future years.

Required:

1. 1. Prepare a schedule that shows for each year, 2019 through 2022, the (a) MACRS depreciation, (b) straight-line depreciation, (c) annual depreciation temporary difference, and (d) accumulated temporary difference at the end of each year.
2. 2. Prepare Gire’s income tax journal entry at the end of (a) 2019, (b) 2020, (c) 2021, and (d) 2022. (Round to the nearest dollar.)
3. 3. Prepare the lower portion of Gire’s income statement for (a) 2019, (b) 2020, (c) 2021, and (d) 2022.

To determine

Prepare a schedule that shows MACRS depreciation from 2019 through 2022.

Explanation of Solution

Prepare a schedule that shows MACRS depreciation from 2019 through 2022:

Year	MACRS Depreciation rate	MACRS Depreciation (Tax purpose)
	(1)	$\left(2\right)=\left(1\right)\times \$60,000$
2019	33.33%	$19,998
2020	44.45%	$26,670
2021	14.81%	$8,886
2022	7.41%	$4,446

Table (1)

To determine

Prepare a schedule that shows straight line depreciation from 2019 through 2022.

Explanation of Solution

Straight-line Depreciation: Under the straight-line method of depreciation, the same amount of depreciation is allocated every year over the estimated useful life of an asset. The formula to calculate the depreciation cost of the asset using the residual value is shown as below:

$\text{Depreciation cost = }\frac{\left(\text{Cost of the asset}-\text{Residual value}\right)}{\text{Estimated useful life of the asset}}$

Prepare a schedule that shows straight line depreciation from 2019 through 2022.

Given, the cost of the asset is $60,000 and the estimated useful life is 4 years. So, the straight line depreciation is $15,000 $\left(\frac{\$60,000}{4\text{ years}}\right)$ for each year.

Year	Straight line Depreciation    (Financial reporting  purpose)
2019	$15,000
2020	$15,000
2021	$15,000
2022	$15,000

Table (2)

To determine

Prepare a schedule that shows the annual depreciation temporary difference from 2019 through 2022.

Explanation of Solution

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.

Prepare a schedule that shows the annual depreciation temporary difference from 2019 through 2022:

Year	MACRS Depreciation (Tax purpose)	Straight line Depreciation    (Financial reporting  purpose)	Temporary difference between annual depreciation
2019	$19,998	$15,000	$4,998
2020	$26,670	$15,000	$11,670
2021	$8,886	$15,000	($6,114)
2022	$4,446	$15,000	($10,554)

Table (3)

Note: The temporary difference of annual depreciation is calculated by subtracting MACRS depreciation (Requirement 1 (a)) and straight line depreciation (Requirement 1 (b)).

To determine

Prepare a schedule that shows the accumulated temporary difference from 2019 through 2022.

Explanation of Solution

Prepare a schedule that shows the accumulated temporary difference from 2019 through 2022:

Year	Temporary difference between annual depreciation	Accumulated Temporary difference
2019	$4,998	$4,998
2020	$11,670	$16,668
2021	($6,114)	$10,554
2022	($10,554)	$0

Table (4)

Note: The accumulated temporary difference is determined by adding the temporary difference of annual depreciation of each of the year from 2019 through 2022.

To determine

Record the income tax journal entry at the end of 2019 for Company C.

Explanation of Solution

Record the income tax journal entry at the end of 2019 for Company C.

Date	Account title and Explanation	Post ref.	Amount
			Debit	Credit
2019
December 31	Income tax expense (1)		$7,499
	Income tax payable (2)			$6,000
	Deferred tax liability (3)			$1,449
	(To record the income tax payable )

Table (5)

• Income tax expense is an expense that decreases the stockholder’s equity and it is increased. Thus, it is debited.
• Income tax Payable is a liability and it is increased. Thus, it is credited.
• Deferred tax liability is a liability and it is increased. Thus, it is credited.

Working note 1: Determine the income tax expense:

$\begin{array}{c}\text{Income tax expense}=\text{Income tax payable}+\text{Deferred tax liability}\\ \text{=\$6,000}+\$1,499\\ \text{=\$7,499}\end{array}$

Working note 2: Determine the income tax payable:

Given, the taxable income is $20,000 and the tax rate is 30%.

$\begin{array}{c}\text{Income tax payable}=\text{Taxable income}\times \text{Corporate tax rate}\\ \text{=\$20,000}\times \text{30\%}\\ \text{=\$6,000}\end{array}$

Working note 3: Determine the deferred tax liability:

Given, the accumulated temporary difference is $4,998 for year 2019 as computed in Table (4) and the tax rate is 30%.

$\begin{array}{c}\text{Deferred tax liability}=\text{Future taxable amount}\times \text{Tax rate}\\ \text{=\$4,998}\times 30\%\\ =\$1,499\text{(rounded off)}\end{array}$

To determine

Record the income tax journal entry at the end of 2020 for Company C.

Explanation of Solution

Record the income tax journal entry at the end of 2020 for Company C.

Date	Account title and Explanation	Post ref.	Amount
			Debit	Credit
2020
December 31	Income tax expense (4)		$11,601
	Income tax payable (5)			$8,100
	Deferred tax liability (6)			$3,501
	(To record the income tax payable )

Table (6)

• Income tax expense is an expense that decreases the stockholder’s equity and it is increased. Thus, it is debited.
• Income tax Payable is a liability and it is increased. Thus, it is credited.
• Deferred tax liability is a liability and it is increased. Thus, it is credited.

Working note 4: Determine the income tax expense:

$\begin{array}{c}\text{Income tax expense}=\text{Income tax payable}+\text{Deferred tax liability}\\ \text{=\$8,100}+\$3,501\\ \text{=\$11,601}\end{array}$

Working note 5: Determine the income tax payable:

Given, the taxable income is $27,000 and the tax rate is 30%.

$\begin{array}{c}\text{Income tax payable}=\text{Taxable income}\times \text{Corporate tax rate}\\ \text{=\$27,000}\times \text{30\%}\\ \text{=\$8,100}\end{array}$

Working note 6: Determine the deferred tax liability:

Given, the accumulated temporary difference is $16,668 for year 2020 as computed in Table (4) and the tax rate is 30%.

$\begin{array}{c}\text{Deferred tax liability}=\left[\left(\begin{array}{l}\text{Future taxable}\\ \text{ amount}\end{array}\right)\times \text{Tax rate}\right]-\left(\begin{array}{l}\text{Beginning deferred }\\ \text{tax liability}\end{array}\right)\\ \text{=}\left(\text{\$16,668}\times 30\%\right)-\$1,499\\ =\$5,000\text{ (rounded off)}-\$1,499\\ =\$3,501\end{array}$

To determine

Record the income tax journal entry at the end of 2021 for Company C.

Explanation of Solution

Record the income tax journal entry at the end of 2021 for Company C.

Date	Account title and Explanation	Post ref.	Amount
			Debit	Credit
2021
December 31	Income tax expense (balancing figure)		$8,366
	Deferred tax liability (7)		$1,834
	Income tax payable (8)			$10,200
	(To record the income tax payable )

Table (7)

• Income tax expense is an expense that decreases the stockholder’s equity and it is increased. Thus, it is debited.
• Deferred tax liability is a liability and it is decreased. Thus, it is debited.
• Income tax Payable is a liability and it is increased. Thus, it is credited.

Working note 7: Determine the deferred tax liability:

Given, the accumulated temporary difference is $10,554 for year 2021 as computed in Table (4) and the tax rate is 30%.

$\begin{array}{c}\text{Deferred tax liability}=\left[\left(\begin{array}{l}\text{Future taxable}\\ \text{ amount}\end{array}\right)\times \text{Tax rate}\right]-\left(\begin{array}{l}\text{Beginning deferred }\\ \text{tax liability}\end{array}\right)\\ \text{=}\left(\text{\$10,554}\times 30\%\right)-\$3,501\left(\text{From 2020}\right)\\ =\$3,166\text{ (rounded off)}-\$3,501\\ =\left(\$1,834\right)\text{ Decrease in deferred tax laibility}\end{array}$

Working note 8: Determine the income tax payable:

Given, the taxable income is $34,000 and the tax rate is 30%.

$\begin{array}{c}\text{Income tax payable}=\text{Taxable income}\times \text{Corporate tax rate}\\ \text{=\$34,000}\times \text{30\%}\\ \text{=\$10,200}\end{array}$

To determine

Record the income tax journal entry at the end of 2022 for Company C.

Explanation of Solution

Record the income tax journal entry at the end of 2022 for Company C.

Date	Account title and Explanation	Post ref.	Amount
			Debit	Credit
2022
December 31	Income tax expense (balancing figure)		$8,834
	Deferred tax liability (9)		$3,166
	Income tax payable (10)			$12,000
	(To record the income tax payable )

Table (8)

• Income tax expense is an expense that decreases the stockholder’s equity and it is increased. Thus, it is debited.
• Deferred tax liability is a liability and it is decreased. Thus, it is debited.
• Income tax Payable is a liability and it is increased. Thus, it is credited.

Working note 9: Determine the deferred tax liability:

Given, the accumulated temporary difference is $0 for year 2022 as computed in Table (4) and the tax rate is 30%.

$\begin{array}{c}\text{Deferred tax liability}=\left[\left(\begin{array}{l}\text{Future taxable}\\ \text{ amount}\end{array}\right)\times \text{Tax rate}\right]-\left(\begin{array}{l}\text{Deferred tax }\\ \text{liability of all years}\end{array}\right)\\ \text{=}\left(\text{\$0}\times 30\%\right)-\left[\$1,499-\$3,501+\$1,834\left(\text{debit}\right)\right]\\ =\$0-\$3,166\\ =\$3,166\left(\text{Decrease in deferred tax liability}\right)\end{array}$

Working note 10: Determine the income tax payable:

Given, the taxable income is $40,000 and the tax rate is 30%.

$\begin{array}{c}\text{Income tax payable}=\text{Taxable income}\times \text{Corporate tax rate}\\ \text{=\$40,000}\times \text{30\%}\\ \text{=\$12,000}\end{array}$

To determine

Prepare the lower portion of Company G’s income statement.

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 lower portion of Company G’s income statement:

Company G
Income Statement
For the year ended 2019
Pretax Operating Income	$24,998
Less: Income tax expense	($7,499)
Net Income	$17,499

Table (9)

Thus, the net income of Company G is $17,499.

To determine

Prepare the lower portion of Company G’s income statement.

Explanation of Solution

Prepare the lower portion of Company G’s income statement:

Company G
Income Statement
For the year ended 2020
Pretax Operating Income	$38,670
Less: Income tax expense	($11,601)
Net Income	$27,069

Table (10)

Thus, the net income of Company G is $27,069.

To determine

Prepare the lower portion of Company G’s income statement.

Explanation of Solution

Prepare the lower portion of Company G’s income statement:

Company G
Income Statement
For the year ended 2021
Pretax Operating Income	$27,886
Less: Income tax expense	($8,366)
Net Income	$19,520

Table (11)

Thus, the net income of Company G is $19,520.

To determine

Prepare the lower portion of Company G’s income statement.

Explanation of Solution

Prepare the lower portion of Company G’s income statement:

Company G
Income Statement
For the year ended 2017
Pretax Operating Income	$29,446
Less: Income tax expense	($8,834)
Net Income	$20,612

Table (12)

Thus, the net income of Company G is $20,612.