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Project Net Income for 1993 to 1997 Using the Percent of Sales Method by fwu19603

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									                            Accounting for Income Tax-problems
                                          by Alfredo Garcia
                                          February 22, 2005

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MULTIPLE CHOICE QUESTIONS

a1.Which of the following creates a permanent difference between financial income and
taxable income?
  a.Interest received on municipal bonds
  b.Completed contract method of recognizing construction revenue
  c.Unearned rent revenue
  d.Accelerated cost recovery on plant and equipment

b2.Which of the following creates a temporary difference between financial and taxable
income?
  a.Interest on municipal bonds
  b.Accelerated cost recovery on plant and equipment
  c.Fines from violation of law
  d.Premiums paid for officer's life insurance (company is beneficiary)

c3.The purpose of an interperiod income tax allocation is to
  a.allow reporting entities to fully utilize tax losses carried forward from a previous year.
  b.allow reporting entities whose tax liabilities vary significantly from year to year to
smooth payments to taxing agencies.
  c.recognize an asset or liability for the tax consequences of temporary differences that
exist at the balance sheet date.
  d.amortize the deferred tax liability shown on the balance sheet.

d4.The result of interperiod income tax allocation is that
  a.wide fluctuations in a company's tax liability payments are eliminated.
  b.tax expense shown in the income statement is equal to the deferred taxes shown on
the balance sheet.
  c.tax liability shown in the balance sheet is equal to the deferred taxes shown on the
previous year's balance sheet plus the income tax expense shown on the income
statement.
  d.tax expense shown on the income statement is equal to income taxes payable for the
current year plus or minus the change in the deferred tax asset or liability balances for the
year.

a5.Which of the following temporary differences ordinarily creates a deferred tax asset?
  a.Accrued warranty costs
  b.Depreciation
  c.Installment sales
  d.Amortization of goodwill
c6.An example of a "deductible temporary difference" occurs when
  a. the installment sales method is used for tax purposes, but the accrual method of
recognizing sales revenue is used for financial reporting purposes.
  b. accelerated depreciation is used for tax purposes but straight line depreciation is used
for accounting purposes.
  c. warranty expenses are recognized on the accrual basis for financial reporting
purposes but recognized as the warranty conditions are met for tax purposes.
d. the completed-contract method of recognizing construction revenue is used for tax
purposes, but the percentage-of-completion method is used for financial reporting
purposes.

a7.Which of the following situations would require interperiod income tax
allocation procedures?
  a.A temporary difference exists because the tax basis of capital equipment is less than
its reported amount in the financial statements.
  b.Proceeds from an insurance policy on capital equipment lost in a fire exceed the book
value of the equipment.
  c.Last period¡¦s ending inventory was understated causing both net income and income
tax expense to be understated.
  d.Nontaxable interest payments are received on municipal bonds.

d8.An item that would create a permanent difference in pretax financial and taxable
incomes would be
a.using accelerated depreciation for tax purposes and straight-line
depreciation for book purposes.
  b.purchasing equipment previously leased with an operating lease in prior years.
  c.using the percentage-of-completion method on long-term construction contracts.
  d.paying fines for violation of laws.

d9.Which of the following is the most likely item to result in a deferred tax asset?
  a. Using accelerated depreciation for tax purposes but straight line depreciation for
accounting purposes
  b. Using the completed-contract method of recognizing construction revenue tax
purposes, but using percentage-of-completion method for financial reporting purposes
  c. Prepaid expenses
  d. Unearned revenues

a10.Which of the following arguments is supportive of allocation of income taxes?
  a.Future predictions of net income are enhanced when income taxes are allocated.
  b.Income tax expense computed under interperiod tax allocation is a better predictor of
future cash flows than income taxes actually paid.
  c.Income tax is not an expense; it is a sharing of profits with government.
  d.Income tax expense based on actual payments is more understandable to users than
allocated income taxes.

d11.Which of the following temporary differences ordinarily results in a deferred tax
liability?
  a.Accrued warranty costs
  b.Subscription revenue received in advance
  c.Unrealized losses on marketable securities
  d.Depreciation

d12.When enacted tax rates change, the asset and liability method of interperiod tax
allocation recognizes the rate change as
  a.a cumulative effect adjustment.
  b.an adjustment to be netted against the current income tax expense.
  c.a separate charge to the current year's net income.
  d.a separate charge or benefit to income tax expense.

c13.Recognizing tax benefits in a loss year due to a loss carryforward requires
  a.only a footnote disclosure.
  b.creating a new carryforward for the next year.
  c.creating a deferred tax asset.
  d.creating a deferred tax liability.

a14.A company would most likely choose the carryforward option for a net
operating loss if the company expected
  a.higher tax rates in the future compared to the past.
  b.lower tax rates in the future compared to the past.
  c.lower earnings in the future compared to the past.
  d.higher earnings in the future compared to the past.

a15.All of the following can result in a temporary difference between pretax financial
income and taxable income except for
  a.payment of premiums for life insurance.
  b.depreciation expense.
  c.contingent liabilities.
  d.product warranty costs.

c16.Which of the following items results in a temporary difference deductible amount for
a given year?
  a.Premiums on officer's life insurance (company is beneficiary)
  b.Premiums on officer's life insurance (officer is beneficiary)
  c.Vacation pay accrual
  d.Accelerated depreciation for tax purposes; straight-line for financial reporting
purposes

d17.Which of the following items results in a temporary difference taxable amount for a
given year?
  a.Premiums on officer's life insurance (company is beneficiary)
  b.Premiums on officer's life insurance (officer is beneficiary)
  c.Vacation pay accrual
  d.Accelerated depreciation for tax purposes; straight-line for financial reporting
purposes

d18.Alpha Company reported net incomes in 2001 and 2002 before sustaining a
significant operating loss in 2003. All of the 2003 loss can be carried back against the
income of 2001 and 2002 for purposes of determining the company¡¦s 2003 income tax
liability. How should the carryback be presented in the company¡¦s 2003 financial
statements?
  a.As an extraordinary item in the income statement
  b.As a revenue from operations in the income statement
  c.As the correction of an error in the retained earnings statement
  d.As a reduction in the operating loss on the income statement for the year 2003

a19.Intraperiod income tax allocation arises because
  a.items included in the determination of taxable income may be presented in different
sections of the financial statements.
  b.income taxes must be allocated between current and future periods.
  c.certain revenues and expenses appear in the financial statements either before or after
they are included in taxable income.
  d.certain revenues and expenses appear in the financial statements but are excluded
from taxable income.

b20.Assuming no prior period adjustments, would the following allocations affect net
income?
     Interperiod Tax Intraperiod Income
     Tax Allocation Tax Allocation
  a. Yes Yes
  b. Yes No
  c. No       Yes
  d. No       No

c21.Which of the following statements is not correct?
  a.All current deferred tax liabilities and assets shall be offset and presented as a single
amount on the balance sheet.
  b.Deferred tax assets related to carryforwards shall be classified as current or
noncurrent on the balance sheet based on their expected date of reversal.
  c.All current and noncurrent deferred tax assets shall be offset and presented as a single
amount on the balance sheet.
  d.Deferred tax liabilities and assets shall be classified as current or nocurrent on the
balance sheet based on the classification of the asset or liability giving rise to the deferred
tax item.

b22.A deferred tax liability arising from the use of an accelerated method of depreciation
for tax purposes and the straight-line method for financial
reporting purposes would be classified on the balance sheet as
  a.a current liability.
  b.a noncurrent liability.
  c.a current liability for the portion of the temporary difference reversing within a year
and a noncurrent liability for the remainder.
  d.an offset to the accumulated depreciation reported on the balance sheet.

c23.International accounting standards currently are moving toward the
  a.no-deferral approach.
  b.partial recognition approach.
  c.comprehensive recognition approach.
  d.discounted comprehensive recognition approach.

b24.If all temporary differences entering into the determination of pretax
accountingincome are considered in the computation of deferred taxes and income tax
expense, then
  a.the no-deferral approach is being applied.
  b.the comprehensive recognition approach is being applied.
  c.the partial recognition approach is being applied.
  d.the net-of-tax method is being applied.

d25.The asset-liability method of interperiod tax allocation currently required by U.S.
GAAP is an example of the
  a.discounted comprehensive recognition approach.
  b.no-deferral approach.
  c.partial recognition approach.
  d.comprehensive recognition approach.

b26.Historically, the United Kingdom has recognized only those deferred tax
liabilities expected to ¡§crystallize.¡¨ The term ¡§crystallize¡¨ is most nearly synonymous
with the term
  a.amortized.
  b.realized.
  c.recognized.
  d.liquidated.

a27. On the statement of cash flows using the indirect method, an increase in the deferred
tax liability would be shown as
a.an addition to net income.
b.a deduction from net income.
c.an increase in investing activities.
d.an increase in financing activities.

b28.In 2002, Eric Corporation reported $90,000 net income before income taxes. The
income tax rate for 2002 was 30 percent. Eric had an unused $60,000 net operating loss
carryforward arising in 2001 when the tax rate was 35 percent. The income tax expense
Eric would report for 2002 would be
  a.$6,000.
 b.$9,000.
 c.$10,500.
 d.$27,000.

a29.The Gayle Corporation reported a $66,000 operating loss in 2002. In the preceding
three years, Gayle reported the following income before taxes and paid the indicated
income taxes:
  Year Income Taxes Tax Rate
  1999 $36,000 $10,800 30%
  2000 24,000 8,400 35%
  2001 48,000 16,200 35%

The amount of tax benefit to be reported in 2002 arising from the tax carryback
provisions of the current tax code would be
  a.$23,100.
  b.$22,500.
  c.$21,300.
  d.$19,200.

c30.The Indy Company had taxable income of $12,000 during 2002. Indy used
accelerated depreciation for tax purposes ($3,400) and straight line depreciation for
accounting purposes ($2,000). Assuming Indy had no other temporary differences, what
would the company¡¦s pretax accounting income be for 2002?
  a. $1,400
  b. $6,600
  c. $13,400
  d. $17,400

b31.The following information is taken from Blackhawk Corporation's 2002 financial
records:
  Pretax accounting income    $1,500,000
  Excess tax depreciation   (45,000)
  Taxable income $1,455,000

Assume the taxable temporary difference was created entirely in 2002 and will reverse in
equal net taxable amounts in each of the next three years. If tax rates are 40 percent in
2002, 35 percent in 2003, 35 percent in 2004, and 30 percent in 2005, then the total
deferred tax liability Blackhawk should report on its December 31, 2002, balance sheet is
  a.$13,500.
  b.$15,000.
  c.$15,750.
  d.$18,000.

d32.The following information was taken from Buccaneer Corporation's 2002
income statement:
  Income before income taxes     $ 1,500,000
 Income tax expense:
   Current   $564,000
   Deferred    36,000 600,000
   Net income      $ 900,000

Buccaneers' first year of operations was 2002. The company has a 30 percent tax rate.
Management decided to use accelerated depreciation for tax purpose and the straight-line
method of depreciation for financial reporting purposes. The amount charged to
depreciation expense in 2002 was $600,000. Assuming no other differences existed
between book income and taxable income, what amount did Buccaneer deduct for
depreciation on its tax return for 2002?
  a.$480,000
  b.$570,000
  c.$600,000
  d.$720,000

a33.Warren Corporation began operations in 1997 and had operating losses of $400,000
in 1998 and $300,000 in 1999. For the year ended December 31, 2000, Warren had a
pretax financial income of $600,000. For 1998 and 1999, assume an enacted tax rate of
30 percent, and for 2000 a 35 percent tax rate. There were no temporary differences in
any of the years. In Warren's 2000 income statement, how much should be reported as
income tax expense?
  a.$0
  b.$30,000
  c.$180,000
  d.$210,000

b34.On December 31, 1999, Alton, Inc., reported a current deferred tax liability of
$140,000 and a noncurrent deferred tax asset of $40,000. At the end of 2000, Alton
reported a current deferred tax liability of $100,000, and a noncurrent deferred tax
liability of $44,000. The deferred tax expense for 2000 is
  a.$144,000.
  b.$44,000.
  c.$36,000.
  d.$4,000.

d35.Eden Company had pretax accounting income of $24,000 during 2002. Eden's only
temporary difference for 2002 relates to a sale made in 2000 and recognized for
accounting purposes at that time. However, Eden uses the installment sales method of
revenue recognition for tax purposes. During 2002 Eden collected a receivable from the
2000 sale which resulted in $6,000 of income under the installment sales method. Eden's
taxable income for 2002 would be
  a.$6,000.
  b.$18,000.
  c.$24,000.
  d.$30,000.
c36.Begal Corporation paid $20,000 in January of 2002 for premiums on a two-year life
insurance policy which names the company as the beneficiary. Additionally, Begal
Corporation's financial statements for the year ended December 31, 2002 revealed the
company paid $105,000 in taxes during the year and also accrued estimated losses on
disposal of unused plant facilities of $200,000. Assuming these facilities were sold in
February of 2003 (at which time a $200,000 loss was recognized for tax purposes) and
that Begal's tax rate is 30 percent for both 2002 and 2003, what amount should Begal
report as asset for net deferred income taxes on its 2002 balance sheet?
  a.$54,000
  b.$57,000
  c.$60,000
  d.$66,000

c37.Dodger Corporation reported a loss for both financial reporting purposes and tax
reporting purposes of $231,000 in 2002. For financial reporting purposes, Dodger
reported income before taxes for years 1999-2001 as listed below:
  1999 $ 66,000
  2000      99,000
  2001      132,000

Assuming Dodger's tax rate is 30 percent in all periods, and that the company uses the
carryback provisions, what amount should appear in Dodger's statements for financial
reporting purposes as a net loss in 2002?
  a.$0
  b.$69,300
  c.$161,700
  d.$234,300

b38.Analysis of the assets and liabilities of Marie Corp. on December 31, 2002, disclosed
assets with a tax basis of $1,000,000 and a book basis of $1,300,000. There was no
difference in the liability basis. The difference in asset basis arose from temporary
differences that would reverse in the following years:
  2003 $80,000
  2004 70,000
  2005 72,000
  2006 40,000
  2007 38,000

The enacted tax rates are 30 percent for the years 2002-2005 and 35 percent for 2006-
2009. The total deferred tax liability on December 31, 2002, should be
  a.$105,000.
  b.$93,900.
  c.$90,000.
  d.$69,000.
c39.Schaeffer Products, Inc., reported an excess of warranty expense over
warranty deductions of $72,000 for the year ended December 31, 2002. This temporary
difference will reverse in equal amounts over the years 2003 to 2005. The enacted tax
rates are as follows:
  2002 40%
  2003 35%
  2004 30%
  2005 25%

The reporting for this temporary difference at December 31, 2002, would be
  a.a deferred tax liability of $28,800.
  b.a deferred tax asset of $28,800.
  c.a current deferred tax liability of $8,400 and a noncurrent deferred tax liability of
$13,200.
  d.a current deferred tax asset of $8,400 and a noncurrent deferred tax asset of $13,200.

d40.In 2003, The Worf Company, reported pretax financial income of $500,000. Included
in that pretax financial income was $90,000 of nontaxable life insurance proceeds
received as a result of the death of an officer; $120,000 of warranty expenses accrued but
unpaid as of December 31, 2003; and $20,000 of life insurance premiums for a policy for
an officer. Assuming that no income taxes were previously paid during the year and
assuming an income tax rate of 40 percent, the amount of income taxes payable on
December 31, 2003, would be
  a.$180,000.
  b.$200,000.
  c.$212,000.
  d.$220,000.

b41.Fieldcrest Company, newly formed on January 1, 2002, prepared a temporary
difference reversal schedule at the end of 2003 that disclosed the following taxable
income (loss) amounts before application of the carryback/carryforward rules:
  2002 $ 64,000
  2003       (128,000)
  2004       (12,000)
  2005       80,000
  2006       20,000

The enacted tax rate for all years was 30 percent. Using the provisions of FASB
Statement No. 109, the total noncurrent deferred tax liability on December 31, 2003, was
  a.$0.
  b.$7,200.
  c.$10,800.
  d.$30,000.

b42.For three consecutive years, 2000-2002, Twins Corporation has reported
income before taxes of $100,000 for both financial reporting purposes and tax reporting
purposes. During this time, Twins income tax rates were as follows:
  2000 20%
  2001 25%
  2002 30%

In 2003, Twins¡¦ tax rate changed to 35 percent. Also in 2003, the company reported a
loss for both financial reporting and tax reporting purposes of $100,000. Assuming the
company uses the carryback provisions, the amount Twins¡¦ should report as an income
tax refund receivable in 2003 is
  a.$20,000.
  b.$25,000.
  c.$30,000.
  d.$35,000.

c43.Viking Corporation reported depreciation of $250,000 on its 2002 tax return.
However, in its 2002 income statement, Viking reported depreciation of $100,000. The
difference in depreciation is a temporary difference that will reverse over time. Assuming
Viking's tax rate is constant at 30 percent, what amount should be added to the deferred
income tax liability in Viking's December 31, 2002, balance sheet?
  a.$30,000
  b.$37,500
  c.$45,000
  d.$75,000

b44.Cowboy Corporation reported depreciation of $450,000 on its 2002 tax return.
However, in its 2002 income statement, Cowboy reported depreciation of $300,000--as
well as $30,000 interest revenue on tax-free bonds. The difference in depreciation is only
a temporary difference, and it will reverse equally over the next three years. Cowboy's
enacted income tax rates are as follows:
  2002 35%
  2003 30%
  2004 25%
  2005 20%

What amount should be included in the deferred income tax liability in Cowboy's
December 31, 2002, balance sheet?
 a.$30,000
 b.$37,500
 c.$45,000
 d.$52,500

c45.The books of the Tracker Company for the year ended December 31, 2002,
showed pretax income of $360,000. In computing the taxable income for federal income
tax purposes, the following timing differences were taken into account:
  Depreciation deducted for tax purposes in excess
  of depreciation recorded on the books     $16,000
 Income from installment sale reportable for tax
 purposes in excess of income recognized on
 the books 12,000

What should Tracker record as its current federal income tax liability at December 31,
2002, assuming a corporate income tax rate of 30 percent?
  a.$99,600
  b.$103,200
  c.$106,800
  d.$108,000

c46.Frey Corporation's income statement for the year ended December 31, 2002, shows
pretax income of $1,000,000. The following items are treated differently on the tax return
and in the accounting records:

           Tax Accounting
Return Records
   Rent income $ 70,000 $120,000
   Depreciation expense 280,000 220,000
   Premiums on officers'
life insurance -- 90,000

Assume that Frey's tax rate for 2002 is 30 percent. What is the amount of income tax
payable for 2002?
  a.$360,000
  b.$320,000
  c.$294,000
  d.$267,000


c47.Inventive Corporation¡¦s income statement for the year ended December 31, 2002,
shows pretax income of $300,000. The following items are treated differently on the tax
return and in the accounting records:

           Tax Accounting
Return Records
   Warranty expense $170,000 $185,500
   Depreciation expense 150,000 100,000
   Premiums on officers'
life insurance -- 60,000

Assume that Inventive¡¦s tax rate for 2002 is 40 percent. What is the current portion of
Inventive's total income tax expense for 2002?
  a.$106,200
  b.$120,200
  c.$130,200
 d.$144,200

The following information relates to questions 48-50:

The Hart Company paid $400,000 in income taxes for the year ended December 31,
2002. Of these taxes, $23,000 related to an extraordinary gain that was taxed at 25%.
The company discontinued one of its business segments during 2002 and realized a tax
savings of $55,000 from the loss on disposition of the segment. The loss was treated for
tax purposes as an ordinary loss and was deducted from ordinary income that was taxed
at 40%. Included in the $400,000 tax payment was $12,000 resulting from a gain on the
sale of equipment. The tax rate on the gain was 25%. All other income items were from
normal operations and were taxed at 40%.

c48.Income from continuing operations for Hart Company for the year 2002 was
  a.$1,000,000.
  b.$1,080,000.
  c.$1,098,000.
  d.$1,050,000.

a49.Income taxes from continuing operations for Hart Company for the year 2002 was
  a.$432,000.
  b.$420,000.
  c.$400,000.
  d.$455,000.

b50.Operating income for Hart Company for the year 2002 was
  a.$1,000,000.
  b.$1,050,000.
  C.$1,098,000.
  d.$1,080,000.

c51.During a year, Great Northern Company reported income tax expense of
$200,000. The amount of taxes currently payable remained unchanged from the
beginning to the end of the year. The deferred tax liability classified as noncurrent that
resulted from the use of MACRS for tax purposes and straight-line depreciation for
financial reporting purposes, increased from $40,000 at the beginning of the year to
$44,000 at the end of the year. How much cash was paid for income taxes during for the
year?
  a.$156,000
  b.$160,000
  c.$196,000
  d.$206,000

a52.For the current year, Northern Pacific Company reported income tax expense of
$45,000. Income taxes payable at the end of the prior year were $20,000 and at the end of
the current year were $27,000. The deferred tax liability classified as noncurrent that
resulted from the use of MACRS for tax purposes and straight-line depreciation for
financial reporting purposes increased from $18,000 at the beginning of the current year
to $23,000 at the end of the current year. How much cash was paid for income taxes
during the year?
  a.$33,000
  b.$45,000
  c.$38,000
  d.$47,000

a53.For the current year, Santa Fe Company reported income tax expense
of $195,000. Income taxes payable at the end of the prior year were $125,000 and at the
end of the current year were $130,000. The deferred tax liability classified as noncurrent
that resulted from the use of MACRS for tax purposes and straight-line depreciation for
financial reporting purposes increased from $120,000 at the beginning of the current year
to $123,000 at the end of the current year. How much cash was paid for income taxes
during the year?
  a.$187,000
  b.$197,000
  c.$195,000
  d.$190,000

a54.For the current year, Northern Pacific Company reported income tax expense of
$11,000. Income taxes payable at the end of the prior year were $9,000 and at the end of
the current year were $10,000. The deferred tax liability classified as noncurrent that
resulted from the use of MACRS for tax purposes and straight-line depreciation for
financial reporting purposes increased from $11,000 at the beginning of the current year
to $13,000 at the end of the current year. How much cash was paid for income taxes
during the year?
  a. $8,000
  b.$10,000
  c.$11,000
  d. $9,000

PROBLEMS

Problem 1
Garrison Designs, Inc., a corporation organized on January 1, 1993, reported the
following incomes (losses) for the ten-year period, 1993-2002:
       Year Income (Loss) Income Tax Rate Income Tax Paid
  1993 16,000 50% $ 8,000
  1994 (40,000) 50 0
  1995 16,000 48 7,680
  1996 24,000 48 11,520
  1997 (32,000) 45 0
  1998 16,000 42 6,720
  1999 32,000 42 13,440
 2000 64,000 34 21,760
 2001 80,000 34 27,200
 2002 (16,000) 30 0

Applying the carryback provisions in the tax law, compute the net amount of taxes paid
(amounts paid less refunds) for the ten-year period ending December 31, 2002.

Solution 1
LO3
Income taxes paid through December 31, 1998, net to zero because the $40,000 net
operating loss in 1994 and the $32,000 net operating loss in 1997 are applied against the
entire income earned for the years 1993, 1995, 1996, and 1998.

Net taxes paid between January 1, 1999, and December 31, 2002, were:

   Year Net Taxes Paid
   1999 $13,440
   2000 (after applying 2002 loss) 16,320
   2001 27,200
   2002 --

Total income taxes actually paid (1993 - 2002) $56,960

Problem 2
The following differences between financial and taxable income were reported by Dider
Corporation for the current year.
  (a)Excess of tax depreciation over book depreciation    $60,000
  (b)Interest revenue on municipal bonds      9,000
  (c)Excess of estimated warranty expense over actual
      expenditures     54,000
  (d)Unearned rent received     12,000
  (e)Fines paid     30,000
  (f)Excess of income reported under percentage-of-completion
    accounting for financial reporting over completed-contract
    accounting used for tax reporting 45,000
  (g)Interest on indebtedness incurred to purchase tax-exempt
      securities 3,000
(h)Unrealized losses on marketable securities recognized for
      financial reporting   18,000

Assume that Dider Corporation had pretax accounting income [before considering items
(a) through (h)] of $900,000 for the current year. Compute the taxable income for the
current year.


Solution 2
LO2
Pretax financial income     $ 900,000
Add (deduct) permanent differences:
    (b) Tax-exempt interest     (9,000)
    (e) Fines paid      30,000
    (g) Interest expense on funds used to purchase tax-exemptsecurities 3,000
    Subtotal     $ 924,000


Add (deduct) timing differences:
   (a)Excess of tax over book depreciation (60,000)
   (c)Excess of warranty expense over actual expenditures   54,000
   (d)Unearned rent received     12,000
   (f)Excess of percentage-of-completion income over completed
     contract income     (45,000)
   (h)Unrealized loss on marketable securities 18,000
     Taxable income      $ 903,000

Problem 3
Walsh Services computed pretax financial income of $220,000 for its first year of
operations ended December 31, 2002. In preparing the income tax return for the year, the
tax accountant determined the following differences between 2002 financial income and
taxable income.

(1) Nondeductible expenses       $40,000
(2) Nontaxable revenues       14,000
(3) Temporary difference--Installment sales reported in financial
  income but not in taxable income    70,000

The temporary difference is expected to reverse in the following pattern.
     2003      $14,000
     2004      32,000
     2005      24,000
       $70,000

The enacted tax rates for this year and the next three years are as follows:
     2002       40%
     2003       35%
     2004       32%
     2005       30%

Use the provisions of FASB Statement No. 109.

(1) Prepare a schedule showing the reversal of the temporary differences and the
computation of income taxes payable and deferred tax assets or liabilities as of December
31, 2002.
(2) Prepare journal entries to record income taxes payable and deferred income taxes.
(3) Prepare the income statement for Walsh Services beginning with ¡§Income from
continuing operations before income taxes¡¨ for the year ended December 31, 2002.

Solution 3
LO4
(1)            Reversal Years
           2002 2003 2004 2005
   Pretax financial income      $220,000
   Nondeductible expense 40,000
   Nontaxable revenue (14,000)
   Taxable financial income $246,000
   Temporary difference:
   Gross profit on installment sales (70,000) $14,000 $32,000          $24,000
   Taxable income $ 176,000 $14,000 $32,000 $24,000
   Enacted tax rate      40% 35% 32% 30%
   Income taxes payable $ 70,400
   Deferred tax liability:
     Current         $ 4,900
     Noncurrent            $10,240 $ 7,200

(2) 2002 Journal Entries:
     Income Tax Expense--Current ¡K¡K¡K¡K¡K¡K¡K¡K¡K 70,400
       Income Taxes Payable ¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K..   70,400

     Income Tax Expense--Deferred ¡K¡K¡K¡K¡K¡K¡K¡K. 22,340
       Deferred Tax Liability--Current ¡K¡K¡K¡K¡K¡K¡K. 4,900
       Deferred Tax Liability--Noncurrent ¡K¡K¡K¡K¡K¡K  17,440

(3) 2002 Income Statement Presentation:
     Income from continuing operations before
     income taxes       $220,000
     Less income taxes:
       Current provision    $ 70,400
       Deferred provision     22,340
                 92,740
     Income from continuing operations      $127,260

Problem 4
Millcroft Inc. computed a pretax financial income of $40,000 for the first year of its
operations ended December 31, 2002. Analysis of the tax and book basis of its liabilities
disclosed $360,000 in unearned rent revenue on the books that had been recognized as
taxable income in 2002 when the cash was received.

The unearned rent is expected to be recognized on the books in the following pattern.
   2003 ¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K..$ 90,000
   2004 160,000
   2005 ¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K.. 70,000
   2006 ¡K¡K¡K¡K.¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K 40,000
     $360,000

The enacted tax rates for this year and the next four years are as follows:
   2002     40%
   2003     36%
   2004     33%
   2005     30%
   2006     32%

Use the provisions of FASB Statement No. 109.

(1) Prepare a schedule showing the reversal of the temporary difference and the
computation of income taxes payable and deferred tax assets or liabilities as of December
31, 2002.(2) Prepare journal entries to record income taxes payable and deferred income
taxes.
(3) Prepare the income statement for Millcroft beginning with ¡§Income from
continuing operations before income taxes¡¨ for the year ended December 31, 2002.


Solution 4
LO4
(1)               Reversal Years
              2002 2003 2004 2005 2006
Taxable financial income $ 40,000 $ 0 $ 0 $ 0 $ 0
Temporary differences:
Unearned rent revenue 360,000
   Rent revenue earned 0 (90,000) (160,000) (70,000) (40,000)
Taxable income (loss) $ 400,000 $(90,000) $(160,000) $(70,000) $(40,000)
Loss carryback:
   2003 carryback (90,000) 90,000
   2004 carryback (160,000)      160,000
   2005 carryback (70,000)       70,000
 Net taxable (deductible)
  amount $ 80,000 $ 0 $ 0 $ 0 $(40,000)
Enacted tax rate 40% 36% 30% 30% 32%

Income taxes payable (40% x $400,000)   $160,000
Deferred tax asset:
     Current (40% x $90,000)   36,000
     Noncurrent (40% x $160,000)      64,000

(2) 2002 Journal Entries:
     Income Tax Expense--Current         160,000
       Income Taxes Payable         160,000

     Deferred Tax Asset--Current    36,000
     Deferred Tax Asset--Noncurrent     92,000
      Income Tax Benefit--Deferred       128,000

(3) 2002 Income Statement Presentation:
   Income from continuing operations before
   income taxes       $40,000
   Less income taxes:
     Current provision    $160,000
     Deferred benefit    (128,000) 32,000
   Income from continuing operations      $ 8,000


Problem 5
Radford Appliances computed a pretax financial loss of $60,000 for the first year of its
operations ended December 31, 2002. Analysis of the tax and book basis of its liabilities
disclosed $80,000 in accrued warranty expenses on the books that had not been
deductible from taxable income in 2002, but would be deductible in future years when
the warranty expenses were paid.

The future warranty payments are expected to occur in the following pattern.
   2003     $14,000
   2004     36,000
   2005     18,000
   2006      12,000
         $80,000

The enacted tax rates for this year and the next four years are as follows:
   2002     40%
   2003     35%
   2004     32%
   2005     30%
   2006     30%

Use the provisions of FASB Statement No. 109.

(1) Prepare a schedule showing the reversal of the temporary difference and the
computation of income taxes payable and deferred tax assets or liabilities as of December
31, 2002.
(2) Prepare journal entries to record income taxes payable and deferred income taxes.
(3) Prepare the income statement for Radford beginning with "Income from continuing
operations before income taxes" for the year ended December 31, 2002.
Solution 5
LO4
(1)                 Reversal Years
             2002 2003 2004 2005 2006
Taxable financial income $(60,000) $ 0 $ 0 $ 0 $ 0
Temporary differences:
Estimated warranty
    payment in future years 80,000
Deductible amount--
    warranty payments       (14,000) (36,000) (18,000) (12,000)
Taxable income (loss) $ 20,000 $(14,000) $(36,000) $(18,000) $(12,000)

Loss carryback:
2003 carryback (14,000) 14,000
2004 carryback (6,000)   6,000
Net taxable (deductible
  amount) $ 0 $ 0 $(30,000) $(18,000) $(12,000)
Enacted tax rate 40% 35% 32% 30% 30%

Income taxes payable (40% x $20,000)   $8,000
Deferred tax asset:
   Current (40% x $14,000)    5,600
   Noncurrent (40% x $6,000)     2,400

(2) 2002 Journal Entries
   Income Tax Expense--Current     8,000
     Income Taxes Payable      8,000
   Deferred Tax Asset--Current    5,600
   Deferred Tax Asset--Noncurrent     2,400
     Income Tax Benefit--Deferred       8,000

(3) 2002 Income Statement Presentation:
   Loss from continuing operations before
   income taxes       $(60,000)
   Less income taxes:
     Current provision     $8,000
     Deferred benefit    (8,000) 0
   Loss from continuing operations      $(60,000)


Problem 6
Seta Associates computed a pretax financial income of $280,000 for the first year of its
operations ended December 31, 2002. Included in financial income was $20,000 of
nondeductible expense and $70,000 gross profit on installment sales that was deferred for
tax purposes until the installments were collected.
The temporary differences are expected to reverse in the following pattern.

     Gross Profit on Collections
     2003      $20,000
     2004     30,000
     2005       20,000
            $70,000

The enacted tax rates for this year and the next three years are as follows:
     2002       40%
     2003       35%
     2004       32%
     2005       30%

(1) Prepare a schedule showing the reversal of the temporary differences and the
computation of income taxes payable and deferred tax assets or liabilities as of December
31, 2002.

(2) Prepare journal entries to record income taxes payable and deferred income taxes.



(3) Prepare the income statement for Seta beginning with "Income from continuing
operations before income taxes" for the year ended December 31, 2002.


Solution 6
LO4
(1)            Reversal Years
          2002 2003 2004 2005
Pretax financial income (loss) $280,000
Nondeductible expense 20,000
Taxable financial income (loss) $300,000
Temporary difference:
Gross profit on installment sales (70,000)
Taxable amount--collections      $20,000 $30,000 $20,000
Taxable income (loss) $230,000 $20,000 $30,000 $20,000

Enacted tax rate 40% 35% 32% 30%
Income taxes payable (40% x $230,000)   $92,000
Deferred tax liability:
Current (35% x $20,000)   7,000
Noncurrent (32% x $30,000) + (30% x 20,000)   15,600

Under the provisions of the proposed modification to FASB Statement No. 109, the
classification of the deferred tax liability into current and noncurrent portions follows the
classification of the underlying installment receivable.

(2) 2002 Journal Entries
   Income Tax Expense--Current    92,000
     Income Taxes Payable     92,000

   Income Tax Expense--Deferred      22,600
     Deferred Tax Liability--Current     7,000
     Deferred Tax Liability--Noncurrent      15,600

(3) 2002 Income Statement Presentation:
    Income from continuing operations before income taxes          $280,000
    Less income taxes:
      Current provision  $92,000
      Deferred provision   22,600 114,600
    Income from continuing operations      $165,400


Problem 7
Cardinal Industries computed a pretax financial income of $118,500 for the first year of
its operations ended December 31, 2002. Cardinal uses an accelerated cost recovery
method on its tax return, and straight-line depreciation on its books.

The difference between the tax and book deduction for depreciation over the five-year
life of the assets acquired in 1999 are as follows:
     2002      $(24,000)
     2003      (39,000)
     2004      (9,000)
     2005 ¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K 30,000
     2006 ¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K 42,000
       $0

The enacted tax rates for this year and the next four years are as follows:
   2002     40%
   2003     38%
   2004     36%
   2005     35%
   2006     32%

Use the provisions of FASB Statement No. 109 and assume that it is more likely than not
that income will be sufficient in all future years to realize any deductible amounts.

(1) Prepare a schedule showing the pattern of depreciation differences, the computation
of income taxes payable, and deferred tax assets or liabilities as of December 31, 2002.
(2) Prepare journal entries to record income taxes payable and deferred income taxes.
(3) Prepare the income statement for Cardinal Industries beginning with "Income from
continuing operations before income taxes" for the year ended December 31, 2002.


Solution 7
LO4
(1)               Reversal Years
            2002 2003 2004 2005 2006
Taxable financial income $118,500
Temporary difference
  between tax and book
  depreciation (24,000) $(39,000) $(9,000) $30,000 $42,000
Taxable income (loss) $ 94,500 $(39,000) $(9,000) $30,000 $42,000
Enacted tax rate 40% 38% 36% 35% 32%

Income taxes payable ($94,500 x 40%) $37,800
Deferred tax asset:
  Noncurrent (38% x $39,000) + (36% x $9,000)  18,060
Deferred tax liability:
Noncurrent (35% x $30,000) + (32% x $42,000)  23,940

Under the provisions of FASB Statement No. 109, the classification of the deferred tax
asset and liability as noncurrent follows the classification of the underlying depreciable
asset.

The deferred tax asset and liability can be offset and reported as a noncurrent deferred tax
liability totaling $5,880 ($23,940 - $18,060).

(2) 2002 Journal Entries
   Income Tax Expense--Current    37,800
     Income Taxes Payable     37,800

   Income Tax Expense--Deferred      5,880
     Deferred Tax Liability--Noncurrent    5,880

(3) 2002 Income Statement Presentation:
   Income from continuing operations before income taxes           $118,500
   Less income taxes:
     Current provision  $37,800
     Deferred provision   5,880 43,680
   Income from continuing operations      $ 74,820


Problem 8
Halverson Company reported taxable income of $60,000 for 2002, its first year of
operations. This amount reflects temporary differences between financial and taxable
income that are scheduled to reverse in subsequent years as shown below. As of
December 31, 2002, the enacted tax rate for 2002 and future years was 40 percent.

           Temporary Difference Reversals
              Taxable (Deductible)
           Year   Amounts
           2003     $(24,000)
           2004       27,000
           2005       (36,000)
           2006       (18,000)
           2007      101,000

Use the provisions of FASB Statement No. 109 and assume that it is more likely than not
that income will be sufficient in all future years to realize any deductible amounts. Also
assume that all the temporary differences relate to noncurrent items.

Compute the amount of the deferred tax assets and/or liabilities that would be reported on
Halverson's balance sheet as of December 31, 2002.

Solution 8
LO2
Since future tax rates are unchanging and since FASB Statement No. 109 classifies
deferred tax assets and liabilities according to the classification of the underlying items
and not the expected time of reversal, no scheduling is necessary in this case.

Noncurrent deferred tax liability: ($50,000 x 0.40) = $20,000

Problem 9
Assume Ernst Corporation has the following income components on its income
statement. Amounts are before tax.
  Income from continuing operations $40,000
  Gain on disposal of business segment 20,000
  Extraordinary gain on early extinguishment of debt 24,000
  Extraordinary loss on property loss (34,000)
  Cumulative effect of change in depreciation method (12,000)
  Total income before considering income taxes 38,000

Assume further that the tax department has applied the current tax regulations and rates to
Ernst¡¦s various income categories and computed the following tax information using the
¡§with and without¡¨ concept required for intraperiod tax allocation:

Tax on total income ($38,000) $14,400
Tax on income from continuing operations ($40,000) 16,200
Tax on total income before considering all irregular and
extraordinary losses 29,000

The tax department also has computed the following incremental tax benefits and
expenses on each individual gain or loss component:

Incremental tax expense--gain components:
    Gain on disposal     $6,500
    Extraordinary gain 6,700
Incremental tax benefit--loss components:
    Extraordinary loss 10,500
    Cumulative effect 4,600

1. Compute the total tax to be allocated to all income components after income from
continuing operations, the total tax benefit allocated to the two loss categories, and the
total tax expense allocated to the two gain categories.

2. Allocate the total tax benefit and tax expense from (1) to the separate gain and loss
components.

Solution 9
LO8
(1) Tax on income from continuing operations $16,200
   Less: Tax on total income¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K... 14,400
   Total tax benefit to be allocated¡K¡K¡K¡K¡K¡K¡K¡K.. $ 1,800

      Tax on total income before considering all
      irregular and extraordinary losses¡K¡K¡K¡K¡K¡K¡K. $29,000
      Less: Tax on total income ¡K¡K¡K¡K¡K¡K¡K¡K¡K¡K.. 14,400
      Tax benefit from loss categories $14,600

      Total tax benefit from loss categories $14,600
      Less: Total tax benefit to be allocated 1,800
      Tax expense allocated to gain categories $12,800

(2)      Allocation to gain categories:
      Total tax expense to allocate to gains $12,800
      Incremental tax--Gain on disposal $ 6,500
      Incremental tax--Extraordinary gain 6,700
      Total expense on gains $13,200

      Tax expense allocated to gain on disposal
      [($6,500 „i $13,200) x $12,800] $ 6,303
      Tax expense allocated to extraordinary gain
      [($6,700 „i $13,200) x $12,800] 6,497
              $12,800
      Allocation to loss categories:
      Total tax benefit allocated to losses $(14,600)
      Incremental tax benefit--Extraordinary loss $10,500
      Incremental tax benefit--Cumulative effect 4,600
   Total tax benefit from losses     $15,100

   Tax benefit allocated to extraordinary loss
   [($10,500 „i $15,100) x ($14,600)] $(10,152)
   Tax benefit allocated to cumulative effect
   [($4,600 „i $15,100) x ($14,600)] (4,448)
   Total tax benefit allocated to all losses $(14,600)

Problem 10
A major conceptual issue associated with interperiod tax allocation is the issue of
discounting the deferred tax amount on the balance sheet to reflect its present value.
Current generally accepted accounting principles do not allow the discounting of deferred
taxes. Some in the profession have suggested, however, that the FASB should reconsider
its position on discounting in light of the Board¡¦s current project on present value-based
measurements in accounting.

Provide arguments for and against the discounting of deferred income taxes.

Solution 10
LO5
Proponents of discounting argue that without discounting the deferred tax asset or
liability, the financial statements fail to indicate the appropriate benefit of the deferral of
taxes or the burden of prepayment of taxes. Dollars related to short-term deferrals appear
to have the same value on the financial statements as dollars related to longer term
deferrals. This inconsistency impairs the comparability of the financial statements.
Discounting would result in temporary differences that do not reverse until many years in
the future being reflected at the present value of the expected future cash flows. The
proponents argue that the discounting of deferred taxes is consistent with currently
generally accepted accounting principles for long-term notes receivable and payable,
pensions, and leases.

Opponents of discounting argue that discounting results in a mismatching of the full tax
effects of taxable transactions with the transactions themselves. The basic transaction that
results in taxes occurs in one period, and the related tax effects are recorded in
subsequent periods through the recording of interest on the deferred tax balance.
Discounting also tends to conceal the consequences of transactions because they are
hidden in the subsequent interest expense. Opponents further argue that deferred taxes are
an interest free loan from the government thus eliminating the need for discounting.

Problem 11
A major conceptual issue regarding the accounting for income taxes is the recognition of
income taxes as expenses. Some would argue that income taxes are not directly related to
revenues or revenue-seeking functions and should not be considered as expenses. Some
view income taxes as a distribution of income similar to dividends. This view would hold
that income taxes, like dividends, are paid only if income is earned. Wages and supplies,
on the other hand, are paid for whether the entity earns a profit or incurs a loss.
Identify arguments that can be made for recognizing income tax as an expense on the
income statement.

Solution 11
LO5
Perhaps the strongest argument for recognizing income taxes as an expense rather than as
a distribution is the fact that the government, like employees or suppliers, renders a
service to the entity. The federal government does not provide services to an entity in
direct proportion to the amount of tax levied, but it does provide services. Payment of
corporate income tax allows an entity to conduct its business under favorable
circumstances such as law, order, and the general organization of the economy. The
federal government contributes to the orderly functioning of society that allows an
enterprise to function and even prosper.

								
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