8/10/2019 Problems with solution on Deferred Tax

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Class Test 1Time: 20 Minutes Marks: 5%

Instructions: Mark your choice of correct answer. Provide detailed workings to support yourchoice of answer. In absence of correct workings, your answer will be considered as deemed

incorrect.

Q1 Shear, Inc. began operations in 2003.Included in Shears 2003 financialstatements were bad debt expenses of $1,400and profit from an installment sale of$2,600. For tax purposes, the bad debts willbe deducted and the profit from theinstallment sale will be recognized in 2004.The enacted tax rates are 30% in 2003 and25% in 2004. In its 2003 income statement,what amount should Shear report as deferredincome tax expense?

a.$300b.$360c.$650d.$780

Q2 On its December 31, 2003 balance sheet,Shin Co. had income taxes payable of$13,000 and a current deferred tax asset of$20,000 before determining the need for avaluation account. Shin had reported acurrent deferred tax asset of $15,000 atDecember 31, 2002. No estimated taxpayments were made during 2003. AtDecember 31, 2003, Shin determined that itwas more likely than not that 10% of thedeferred tax asset would not be realized. In

its 2003 income statement, what amountshould Shin report as total income taxexpense?a.$ 8,000b.$ 8,500c.$10,000d.$13,000

8/10/2019 Problems with solution on Deferred Tax

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1. (a)(a) The deferred portion of income tax expense can be computed by determining the tax effect of the two temporary differences.The installment sale profit results in a future taxable amount in 2004 of $2,600, and the bad debt expense results in a futuredeductible amount of $1,400.The deferred tax consequences of these temporary differences will be measured by Shear in 2003 using the enacted tax rateexpected to apply to taxable income in the year the deferred amounts are expected to be settled. The following journal entry isnecessary to record the deferred tax liability related to the installment sale:

Deferred tax expense 650Deferred tax liability 650[$2,600 x .25]To record the deferred tax asset related to the bad debt expense, the following journal entry is required:Deferred tax asset 350Deferred tax expense 350[$1,400 x .25]The amount of deferred tax expense to be reported by Shear in its 2003 income state ment is $300 ($650 $350). Note that one

journal entry could have been used. Using two entries more clearly shows the opposite effect of an asset versus a liability ondeferred tax expense.Here journal entries are included to provide you the understanding. However, for examination purposes, calculations supporting thedeferred tax asset amounts, the deferred tax liability amounts and the deferred tax expense amount would have been suffice.

2. (c)From 12/31/02 to 12/31/03, the deferred tax asset increased by $5,000 (from $15,000 to $20,000). Income taxes payable at

12/31/03 are $13,000. Based on this information, the following journal entries can be recreated.Income tax expensecurrent 13,000Income tax payable 13,000

Deferred tax asset 5,000Income tax expensedeferred 5,000

An additional entry would be prepared by Shin to record an allowance to reduce the deferred tax asset to its realizable value (10% x$20,000 = $2,000).

Income tax expensedeferred 2,000Allowance to reduce deferredtax asset to realizable value 2,000

Based on these three entries, total 2003 income tax expense is $10,000 ($13,000$5,000 + $2,000).

Income Tax expense presentation in the income statement would be:

Income Tax Expense

Income tax Payable 13,000Less: Deferred tax asset (5,000)Add: Allowance to reduce DTA 2000

10,000