Problem:
Updike and Patterson Investments Inc (UPI) holds equity investments with a cost basis of $250,000. UPI accounts for these investments as available-for-sale securities. As such, the investments are carried on the balance sheet as fair value, with unrealized gains and losses reported in other comprehensive income.
At the end of Year 1, the fair value of these investments has declined to $220,000. Consequently, UPI reports an unrealized loss for financial reporting purposes of $30,000 in other comprehensive income, which creates a temporary tax difference. As of December 31, Year 1, UPI management determines that it is more likely than not that the company will be able to deduct capital losses on these investments for tax purposes if they are realized.
As of December 31, Year 2, UPI management evaluates its assessment of tax position and determines that it is more likely than not that the company will not be able to take a deduction for any capital loss on these investments. UPI's tax rate is 40 percent
Required:
Prepare journal entries to account for income taxes in Year 1 and Year 2