On December 31, 2010, Quirk Inc. has taxable temporary differences of $2,200,000 and a future income tax liability of $924,000. These temporary differences are due to Quirk having claimed CCA in excess of book depreciation in prior years. Quirk’s year-end is December 31. At the end of December 2011, Quirk’s substantially enacted tax rate for
2011 and future years was changed to 44%.
For the year ended December 31, 2011, Quirk’s accounting loss before tax was ($494,000). The following data are also available.
1. Pension expense was $87,000 while pension plan contributions were $111,000 for the year (only actual pension contributions are deductible for tax).
2. Business meals and entertainment were $38,000 (one-half deductible for tax purposes).
3. For the three years ending December 31, 2010, Quirk had cumulative, total taxable income of $123,000 and total tax expense/taxes payable of $51,660.
4. During 2011, the company booked estimated warranty costs of $31,000 and these costs are not likely to be incurred until 2015.
5. In 2011 the company incurred $150,000 of development costs (only 50% of which are deductible for tax purposes).
6. Company management has determined that only one-half of any loss carryforward at the end of 2011 is more likely than not to be realized.
7. In 2011, the amount claimed for depreciation was equal to the amount claimed for CCA.
Instructions
Prepare the journal entries to record taxes for the year ended December 31, 2011, and the tax reconciliation note.
Prior year tax rate: $924,000 / $2,200,000 = 42%
Balance | | | Deductible | | | (PE GAAP) |
Sheet | | | (Taxable) | | Future Tax | Current |
Account | Carrying | Tax | Temporary | Tax | Asset | Long- |
Dec. 31, 2010 | Amount* | Basis* | Differences | Rate | (Liability) | Term |
Property, plant, & equipment | | | ($2,200,000) | 42% | ($924,000) | LT |
Future income tax liability, December 31, 2011 ($2,200,000 x 44%) | 968,000 | | ||||
Increase in future income tax liability from December 31, 2010 | $44,000 | |
* not given in the problem
Balance | | | Deductible | | | (PE GAAP) | |
Sheet | | | (Taxable) | | Future Tax | Current | |
Account | Carrying | Tax | Temporary | Tax | Asset | Long- | |
Dec. 31, 2011 | Amount* | Basis* | Differences | Rate | (Liability) | Term | |
Pension liability | | | ($24,000) | 44% | ($10,560) | LT | |
Warranty liability | | | 31,000 | 44% | 13,640 | C | |
Increase in Pension Future income tax liability for 2011 | (10,560) | | | ||||
Increase in Warranty Future income tax asset for 2011 | $13,640 | $ | |
* not given in the problem
Calculation of loss for tax purposes and loss carryforward:
Accounting loss ($494,000)
Permanent differences:
Development costs (50% X $150,000) 75,000
Meals and entertainment (50% X $38,000) 19,000
Reversing differences:
Warranty expense 31,000
Pension funding > expense (24,000)*
Loss for income tax purposes (393,000)
Carryback to prior years 123,000
Loss available for carryforward (270,000)
50% more likely than not to be realized 50%
Portion of loss to recognize as benefit (135,000)
Tax rate 44%
Future tax asset and current benefit ($59,400)
* ($87,000 – $111,000 = –$24,000)
2011 Income tax journal entries:
Income Tax Recoverable ($123,000 x 42%). 51,660
Current Tax Benefit – loss carryback 51,660
Future Income Tax Asset – loss carryforward 59,400
Current tax benefit – loss carryforward 59,400
Future Income Tax Expense
($2,200,000 X (.44 –.42))........... 44,000
Future Income Tax Liability......... 44,000
Future Income Tax Asset - warranty...... 13,640
Future Income Tax Benefit........... 13,640
($31,000 X .44 = $13,640)
Future Income Tax Expense – pension liability 10,560
Future Income Tax Liability......... 10,560
($24,000 X .44 = $10,560)
Income statement (partial)
Loss before income taxes ($494,000)
Income taxes
Current benefit – loss carryback $51,660
Future benefit 18,480* 70,140
Net income ($423,860)
* ($59,400 – $44,000 + $13,640 – $10,560 = $18,480)
Reconciliation – Statutory rate to effective rate:
| | | | | | Divided by | |
| | | | | | Accounting | |
| | | | @ 44% | | loss | |
Accounting loss | $494,000 | | $217,360 | | 44.00% | ||
Non-deductible half of development costs | 75,000 | | (33,000) | | (6.68%) | ||
Non-deductible portion of meals/entertainment | 19,000 | | (8,360) | | (1.69%) | ||
| | | | 176,000 | | 35.63% | |
Tax rate adjustment on reversing differences ($2,200,000 x .02) | 2,200,000 | | (44,000) | | (8.91%) | ||
½ of loss carryforward not likely to recover | 135,000 | | (59,400) | | (12.02%) | ||
Tax rate adjustment on loss carryback ($123,000 x .02) | 123,000 | | (2,460) | | (0.50%) | ||
| | | $70,140 | | 14.20% | ||
Effective tax rate ($70,140 / $494,000 = 14.20%) | | | | 14.20% | |||
Quirk Inc.’s effective tax rate differs from the statutory rate due to permanent differences that will never be subject to tax; a change in tax rate that impacts temporary differences that are being carried forward; not recognizing the future tax benefit of half of the loss carryforward; and, recovery of prior year income taxes at a tax rate different than the current year rate.
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