Chapter 20, Problem 20.16P

To determine

Deferred tax:

Deferred Tax is a liability account that shows the reconciliation amount that occurred due to differences between the estimated income tax amount (Income Tax Expense account) and the outstanding amount of income tax (Income Tax Payable account).

Contingency:

Loss contingency is a provision created in advance for the probable future expense depends upon the expected future event such as adverse outcome of a lawsuit.

To journalize: The effects on Incorporation SS records as on December 31, 2016 for each item:

Explanation of Solution

(a)

Journal of the Incorporation SS for investments:

Date	Account Title and Explanation	Debit	Credit
May	Investment (1)	$40,000
2016	Gain on investment		$40,000
	(To record accumulated depreciation correction)

Table (1)

Working notes:

Calculation of Investment:

$\begin{array}{c}\text{Investment= Sale}-\text{original cost}\\ \text{=\$220,000}-\$180,000\\ =\$40,000\end{array}$  (1)

Investment is an asset. There is an increase in asset value. Therefore, it is debited.

Gain on investment is a liability. There is an increase in liability value. Therefore, it is credited.

(b)

Journal for the fair value of Incorporation 2016:

Date	Account Title and Explanation	Debit	Credit
	Unrealized loss- OCI	$16,000
	Fair value adjustment (2)		$16,000
	(To record accumulated depreciation correction)

Table (2)

Unrealized loss is a deferred asset. There is an increase in asset value. Therefore, it is debited.

Fair value adjustment is a contra liability. There is an increase in liability value. Therefore, it is credited.

Working notes:

Determine the fair value adjustment needed Dec 31, 2016:

Particulars	Amount ($)
Investment  May 2016	250,000
Add: Error adjustment	40,000
Corrected balance Dec, 31, 2016	290,000
Less: Fair value Dec, 31, 2016	(274,000)
Fair value adjustment needed Dec, 31, 2016	16,000

Table (3)

Hence, the fair value of adjustment is $16,000. (2)

(c)

Journal for loss of Incorporation SS:

Date	Account Title and Explanation	Debit	Credit
	Loss –lawsuit	$130,000
	Liability – lawsuit		$130,000
	(To record accumulated depreciation correction)

Table (4)

Loss is a deferred asset. There is an increase in asset value. Therefore, it is debited.

Liability – lawsuit is a liability. There is an increase in liability value. Therefore, it is credited.

(d)

Journal for cost of goods sold of Incorporation SS:

Date	Account Title and Explanation	Debit	Credit
	Cost of goods sold	$132,000
	Inventory		$132,000
	(To record cost of inventory)

Table (5)

Cost of goods sold is an expense. There is a decrease in asset value. Therefore, it is debited.

Inventory is an asset. There is a decrease in assets value. Therefore, it is credited.

(e)

Journal for equipment of Incorporation SS:

Date	Account Title and Explanation	Debit	Credit
	Property, plant, and equipment	$80,000
	Retained earnings		$48,000
	Income tax payable (3)		$32,000
	(To record income tax payable)

Table (6)

Working notes:

Calculation of Income tax payable:

$\begin{array}{c}\text{Income tax payable=\$80,000}\times \text{40\%}\\ \text{=\$32,000}\end{array}$ (3)

Inventory is an asset. There is an increase in assets value. Therefore, it is debited.

A retained earnings is a component of stock holder’s equity

Income tax payable is a liability. There is an increase in liability value. Therefore, it is credited.

(f)

Journal for depreciation of equipment:

Date	Account Title and Explanation	Debit	Credit
	Depreciation expense   (4)	$20,000
	Accumulated depreciation		$20,000
	(To record accumulated depreciation)

Table (7)

Working notes:

Calculation of depreciation expense:

$\begin{array}{c}\text{Depreciation expense=}\left(\frac{\$80,000}{4}\right)\\ =\$20,000\end{array}$ (4)

Depreciation is an expense. An expense will reduce the stock holders’ equity. There is a decrease in the value of the stock holders’ equity. Hence debit depreciation for$20,000.

Accumulated depreciation is a contra asset. There is a decrease in assets value. Therefore, it is credited.

(g)

Journal for Income tax of Incorporation SS:

Date	Account Title and Explanation	Debit	Credit
	Income tax payable	$44,800
	Deferred tax assets (5)	$51,100
	Income tax expense (6)		$95,900
	(To record the estimated liability warranty)

Table (8)

Income tax payable and deferred tax assets are liability. There is an increase in liability value. Therefore, it is debited.

Income tax expense is a liability. There is a decrease in liability value. Therefore, it is debited.

Working notes:

Calculation of future deductible amounts (not included in taxable income):

Particulars	Amount($)	Amount($)
Lawsuit expected to be settled in 2019 (c)	130,000
Add: Unrealized loss on investment (b)	16,000
Total future deductible amounts	146,000
Multiply: Tax rate effective after 2016	35%
Deferred tax asset		(51,100)
Income tax expense as adjusted		416,100

Table (9)

Hence, the future deductible amount is $416,100.

Hence, the deferred tax asset amount is $51,100. (5)

Determine the reduction in income tax expense:

Particulars	Amount($)
Income tax expense, as reported	512,000
Less: Income tax expense, as adjusted	416,100
Reduction in income tax expense	$95,900

Table (10)

Hence, the reduction in income tax expense is $95,900.

(6)

Determine the income tax payable:

Particulars	Amount ($)
Taxable income as reported	1,280,000
Add: Realized gain on sale of investment (a)	40,000
Less: Inventory overstatement (d)	(132,000)
Less: Additional depreciation(f)	(20,000)
Multiply: Taxable income, as adjusted	1,168,000
Tax rate	40%
Income tax payable	467,200

Table (11)

Hence, the income tax payable is $467,200.