Billsby Corporation had a tax liability for 20X7 of $20,000 based on a tax rate of 40%, but the accounting staff needs your help in determining the tax expense and deferred tax amounts for 20X7. The enacted tax rates for the future periods are 35% for 20X8 - 20Y2, and then 30% for 20Y3 - 20Y6. The company does not believe that temporary differences can be reasonably projected beyond those periods. The taxable income for 20X8 was $100,000.
Billsby also owned a 30% interest in Windrop, Inc. which reported income of $50,000 and $60,000 in 20X7 and 20X8, respectively. Billsby received dividends of $5,000 and $8,000 from Windrop for 20X7 and 20X8, respectively. Billsby expects this pattern of earnings and dividends to continue over the next ten years.
Billsby estimated warranty expense to be $7,500 in 20X7 and $10,000 in 20X8. Actual warranty cost for the two years was $6,000 and $12,000, respectively. The bad debts expense recognized on the income statement was $15,000 in 20X7 and $20,000 in 20X8. Actual bad debt write-offs per the tax return were $10,000 in 20X7 and $15,000 in 20X8.
On January 1, 20X8 Billsby also received $30,000 of rent in advance covering a two year rental agreement, and $5,000 for interest income on municipal bonds (classified as held-to-maturity securities). The bonds mature in 20Y0.
Other data with respect to Billsby's depreciation expense calculations is as follows:
Year Cost Recovery Depreciation
20X7 $24,000* $10,000
20X8 24,000 10,000
20X9 17,000 10,000
20Y0 12,000 10,000
20Y1 9,000 10,000
(amounts continue in next columns)
*Includes some immediate expensing per Section 179.
Year Cost Recovery Depreciation
20Y2 9,000 10,000
20Y3 8,500 10,000
20Y4 4,500 10,000
20Y5 ---- 10,000
20Y6 ---- 10,000
Totals $ 108,000 $ 100,000
Key Terminology
Taxable Income: Income (per IRC) less deductions (per IRC) per tax return
Tax Liability: Taxes owed to government per income tax return (based on Taxable Income) Net Income: Revenue minus expenses per GAAP
Provision for Income Taxes or Income Tax Expense: An income statement amount determined based upon the taxable/deductible GAAP components. Includes the amount currently payable per tax return (tax liability) plus/minus any deferred amounts computed per schedules.
Deferred Income Taxes: A theoretical/conceptual liability that will be paid, only if the entity continues to generate a profit into the future continues as a going concern. Deferred taxes are not a legal obligation.
Required:
a. Determine the tax expense and the deferred tax amounts for 20X7 and 20X8. Be sure to separate current and long-term amounts and to present amounts before and after netting.
b. Determine the tax liability amount for 20X8.
c. Prepare all necessary journal entries for the two year period (20X7 - 20X8).
d. Prepare a partial income statement for 20X7 showing earnings before tax, provision for income tax, and net income. (A good example of this format would be schedule M-1 from a corporate income tax return)