Chapter 16 Accounting for Income Taxes
Use the following to answer questions 106–110:
Information for Hobson Corp. for the current year ($ in millions):
Income from continuing operations before tax
$150
Loss on discontinued operation (pretax)
30
Temporary differences (all related to operating income):
Accrued warranty expense in excess of expense
included in operating income
10
Depreciation deducted on tax return in excess of
depreciation expense
25
Permanent differences (all related to operating income):
Nondeductible portion of entertainment expense
5
The applicable enacted tax rate for all periods is 40%.
106. How much tax expense on income from continuing operations would be reported in Hobson‘s
income statement?
a. $56 million.
b. $60 million.
c. $62 million.
d. $50 million.
107. What should Hobson report as income from continuing operations?
a. $ 94 million.
b. $ 90 million.
c. $ 88 million.
Chapter 16 Accounting for Income Taxes
d. $150 million.
108. What should Hobson report as net income?
a. $70 million.
b. $72 million.
c. $75 million.
d. $88 million.
109. What is Hobson’s income tax payable for the current year?
a. $52 million.
b. $50 million.
c. $48 million.
d. $44 million.
110. How should Hobson report tax on the discontinued operation?
a. A tax receivable of $12 million in the balance sheet.
b. A tax benefit of $12 million to net against the $30 million pretax loss.
c. A deferred tax asset of $12 million in the balance sheet.
d. None of these answer choices are correct.
Chapter 16 Accounting for Income Taxes
Matching Pair Questions
111. Listed below are 5 terms followed by a list of phrases that describe or characterize each of the
terms. Match each phrase with the number for the most correct term.
TERM
PHRASE
NUMBER
1. Operating loss carryback
Will generate a refund of taxes paid in prior years.
____
2. Valuation allowance
Is a process of allocating income tax expense among
income from continuing operations,
____
3. Taxable income
Arises when future deductible amounts are created
by temporary differences.
____
4. Deferred tax asset
Reduces the net deferred tax asset and is allocated
between current and noncurrent in a balance sheet
____
5. Intraperiod tax allocation
Is the basis for computing the tax liability for taxes
currently payable.
____
Answer:
TERM
1. Operating loss carryback
Will generate a refund of taxes paid in prior years.
2. Valuation allowance
Is a process of allocating income tax expense among
income from continuing operations,
3. Taxable income
Arises when future deductible amounts are created by
temporary differences.
4. Deferred tax asset
Reduces the net deferred tax asset and is allocated
between current and noncurrent in a balance sheet
5. Intraperiod tax allocation
Is the basis for computing the tax liability for taxes
currently payable.
112. Listed below are 5 terms followed by a list of phrases that describe or characterize each of the
terms. Match each phrase with the number for the most correct term.
TERM
PHRASE
NUMBER
1. Interperiod tax allocation
Will always create a deferred tax asset.
____
2. Deferred tax asset
Is usually a revenue or expense item that is
excluded or not deductible in determining taxable
income.
____
3. Deferred tax liability
Arises when future taxable amounts are created
by temporary differences.
____
4. Operating loss carryforward
Is the process of allocating income taxes among
two or more reporting periods.
____
5. Permanent difference
Is reduced by a valuation allowance if realization
of future tax benefit is not more likely than not.
____
TERM
PHRASE
1. Interperiod tax allocation
Will always create a deferred tax asset.
income.
3. Deferred tax liability
Arises when future taxable amounts are created
by temporary differences.
4. Operating loss carryforward
Is the process of allocating income taxes among
two or more reporting periods.
Chapter 16 Accounting for Income Taxes
113. Listed below are five independent situations. For each situation indicate (by letter) whether it
will create (A) a deferred tax asset, (L) a deferred tax liability, or (N) neither.
__
Research and development costs reported in the income statement but elected to be
capitalized and amortized over five years for tax purposes.
__
An operating loss carryforward.
__
Organization costs reported in the income statement but amortized and deducted over
five years for tax purposes.
__
Premiums paid on life insurance policies covering key corporate executives.
__
The nondeductible portion of travel and entertainment expenses.
Organization costs reported in the income statement but amortized and deducted over
five years for tax purposes.
114. Listed below are five independent situations. For each situation indicate (by letter) whether it
will create (A) a deferred tax asset, (L) a deferred tax liability, or (N) neither.
____ An operating loss carryback.
____ Warranty expense, tax deductible when paid.
____ Interest earned on investments in state and local government bonds.
____ Current year charitable contributions not currently deductible due to tax limitations but
which can be carried forward to future tax years.
____ Prepaid expenses, tax deductible when paid.
115. Listed below are 5 terms followed by a list of phrases that describe or characterize each of the
terms. Match each phrase with the number for the most correct term.
TERM
PHRASE
NUMBER
1. Permanent difference
A “plug” for the net effect of the current tax
liability and changes in deferred tax assets and
liabilities.
____
2. Valuation allowance
No tax consequences.
____
3. Balance sheet classification
“More likely than not” test.
____
4. Income tax expense
Produces future taxable amounts or future
deductible amounts.
____
5. Temporary difference
Same as the related asset or liability.
____
Answer:
Chapter 16 Accounting for Income Taxes
Chapter 16 Accounting for Income Taxes
Problems
116. Roberts Corp. reports pretax accounting income of $200,000, but due to a single temporary
difference, taxable income is only $150,000. At the beginning of the year, no temporary
differences existed. Roberts is subject to a tax rate of 40%.
Required:
Prepare the compound journal entry to record Roberts Corp.’s income taxes. Show well-
labeled computations.
Income tax expense (to balance)
Use the following to answer question 117–118:
In its 2016 annual report to shareholders, Black Inc. disclosed the following information about income
taxes.
A reconciliation of income taxes computed at the United States federal statutory income tax rate (35%)
to the provision (benefit) for income taxes reflected in the Consolidated Statement of Operations for
the years ended December 31, 2016, 2015, 2014, is as follows ($ in millions):
2016
2015
2014
Provision (benefit) for income taxes at United States
federal statutory rate of 35% ………………………………………………
$5.2
$ (4.9
)
$(11.3
)
State and local income taxes, net of federal income tax benefit ….
(4.1
)
(4.3
)
(3.9
)
Taxes on foreign income which differ from the
United States statutory rate ……………………………………………….
(2.5
)
0.6
(0.7
)
Losses with no tax benefit …………………………………………………….
2.8
4.2
6.2
Benefit of foreign sales corporation. ……………………………………….
—
—
(0.5
)
Other ………………………………………………………………………………….
0.5
(3.2
)
—
____
____
_____
$1.9
$ (7.6)
$(10.2)
The significant components of the net deferred tax assets at December 31, 2016 and 2015, were as
follows ($ in millions):
2016
2015
Deferred Tax Assets:
Chapter 16 Accounting for Income Taxes
Net operating loss carryforwards
$141.6
$139.0
Sales incentive discounts.
30.6
22.8
Inventory valuation reserves
15.0
8.3
Postretirement benefits
7.8
8.2
Other
64.2
74.1
Valuation allowance
(52.7
)
(71.8
)
Total deferred tax assets
206.5
180.6
Deferred Tax Liabilities:
Tax over book depreciation
23.5
24.2
Tax over book amortization of patent
18.2
17.9
Other
19.1
16.3
Total deferred tax liabilities
60.8
58.4
Net deferred tax assets
$145.7
$122.2
117. Why are the depreciation and patent amortization listed as deferred tax liabilities?
118. Estimate the effective tax rate for Black Inc. in 2016. Why is it different from the 35% federal
statutory rate?
119. Several years ago, Western Electric Corp. purchased equipment for $20,000,000. Western
uses straight-line depreciation for financial reporting and MACRS for tax purposes. At
December 31, 2015, the carrying value of the equipment was $18,000,000 and its tax basis
was $15,000,000. At December 31, 2016, the carrying value of the equipment was
Chapter 16 Accounting for Income Taxes
$16,000,000 and the tax basis was $11,000,000. There were no other temporary differences
and no permanent differences. Pretax accounting income for the current year was
$25,000,000. A tax rate of 35% applies to all years.
Required:
Prepare one journal entry to record Western’s income tax expense for the current year. Show
well-labeled computations for the income tax payable and the change in the deferred tax
account.
120. North Dakota Corporation began operations in January 2015 and purchased a machine for
$20,000. North Dakota uses straight–line depreciation over a four-year period for financial
reporting purposes. For tax purposes, the deduction is 50% of cost in 2015, 30% in 2016, and
20% in 2017. Pretax accounting income for 2015 was $150,000, which includes interest
revenue of $20,000 from municipal bonds. The enacted tax rate is 30% for all years. There are
no other differences between accounting and taxable income.
Required:
Prepare a journal entry to record income taxes for the year 2015. Show well-labeled
computations for the amount of income tax payable and the change in the deferred tax
account.
121. The following information is for Hulk Gyms’ first year of operations. Amounts are in millions
of dollars. The enacted tax rate is 30%.
Future
Year
Future Taxable Amounts
Amounts
2016
2017
2018
2019
2020
Total
Accounting income
$60
Temporary difference:
Prepaid insurance
(12
)
$ 3
$ 3
$ 3
$ 3
$ 12
Taxable income
$ 48
Required:
Prepare a compound journal entry to record the income tax expense for the year 2016. Show
well-labeled computations.
Accounting income
Temporary difference:
(change in deferred tax balance per below)
1,500
Income tax payable
37,500
Accounting income
Permanent diff – municipal bond interest
)
Depreciation diff (20K x 50%) – (20K x 25%)
)
$5,000
Taxable income
125,000
Enacted tax rate
30%
$37,500
Deferred tax liability (5K x 30%)
$1,500
Less: Beginning balance
0
Change in balance
$1,500
122. Gallo Light began operations in 2016. The company sometimes sells used warehouses on an
installment basis. In those cases, Gallo Light reports income in its income statement in the
year of the sale. In its income tax return, though, Gallo Light reports installment income by the
installment method. Installment income in 2016 was $90,000, which Gallo Light expects to
collect equally over the next three years. The tax rate is 30%, but based on an enacted law, is
scheduled to become 35% in 2018.
Gallo Light’s pretax accounting income from the 2016 income statement was $830,000, which
includes $40,000 of interest revenue from an investment in municipal bonds. There were no
differences between accounting income and taxable income other than those described above.
Required:
(1.) Prepare the appropriate journal entry to record Gallo Light’s 2016 income taxes. Show
calculations.
(2.) What is Gallo Light’s 2016 net income?
123. EZ, Inc., reports pretax accounting income of $400,000, but due to a single temporary
difference, taxable income is $500,000. At the beginning of the year, no temporary differences
existed. EZ is subject to a tax rate of 40%.
Required:
Prepare the appropriate journal entry to record EZ’s income taxes. Show well-labeled
computations.
124. In the current year, Bruno Corporation collected rent of $3,600,000. For income tax reporting,
the rent is taxed when collected. For financial reporting, the rent is recognized as income in
the period earned. At the end of the current year, the unearned portion of the rent collected in
the current year amounted to $400,000. Bruno had no temporary differences at the beginning
of the current year. Assume an income tax rate of 30%.
Required:
The current year’s income tax liability from the tax return is $800,000. Prepare the journal
entry to record income taxes for the year. Show well-labeled computations.
125. At the end of its first year of operations, Prince Charming Corporation had a current liability
of $300,000 for unearned rent. This was the only difference between pretax accounting
income and taxable income. Assume an income tax rate of 40%.
Required:
The tax liability from the tax return is $750,000. Prepare the journal entry to record income
taxes for Prince Charming’s first year of operations. Show well-labeled computations.
126. Pocus, Inc., reports warranty expense when related products are sold. For tax purposes, the
warranty costs are deductible as incurred. At the end of the current year, Pocus has a warranty
liability of $200,000 and taxable income of $20,000,000. At the end of the previous year,
Pocus reported a deferred tax asset of $80,000 related to the difference in reporting warranty
expense, its only temporary difference. The enacted tax rate is 30% each year.
Chapter 16 Accounting for Income Taxes
Required:
Prepare the appropriate journal entry for Pocus to record the income tax provision for the
current year. Show well-labeled supporting computations.
127. Pocus Inc. reports warranty expense when related products are sold. For tax purposes, the
warranty costs are deductible as incurred. At the end of the current year, Pocus has a warranty
liability of $500,000 and taxable income of $50,000,000. At the beginning of the current year,
Pocus reported a deferred tax asset of $210,000 related to the difference in reporting warranty
expense, its only temporary difference. The enacted tax rate is 40% each year.
Required:
Prepare the appropriate journal entry for Pocus to record the income tax provision for the
current year. Show well-labeled computations to support the three amounts in your journal
entry.
128. Gore Company, organized on January 2, 2016, had pretax accounting income of $7,000,000
and taxable income of $10,000,000 for the year ended December 31, 2016. The 2016 tax rate
was 40%. The only difference between book and taxable income is estimated warranty costs.
Expected payments and scheduled enacted tax rates are as follows:
Chapter 16 Accounting for Income Taxes
2017
$1,000,000
35%
2018
500,000
35%
2019
500,000
35%
2020
1,000,000
30%
Required:
Prepare one compound journal entry to record Gore’s provision for taxes for the year 2016.
Income tax expense (to balance)
Deferred tax asset
Accounting income
Temp. diff – estimated
Taxable income
Enacted tax rate
Tax payable currently
Deferred tax asset
Less: Beginning balance
Change in balance
Use the following to answer questions 129–131:
In LMC’s 2016 annual report to shareholders, it disclosed the following information about its income
taxes:
INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences between the amounts of
assets and liabilities for accounting purposes and the amounts used for income tax purposes.
Significant components of the Company’s deferred tax liabilities and assets as of December 31 were as
follows:
($ in millions)
2016
2015
129. Explain why LMC has a $209.4 million valuation allowance for its deferred tax assets.
130. Will LMC report $819.9 million as a liability in its balance sheet at December 31, 2016?
Explain.
131. Indicate why LMC lists net operating loss carryforwards as a component of deferred tax
Chapter 16 Accounting for Income Taxes
assets.
132. At the end of the preceding year, World Industries had a deferred tax asset of $17,500,000,
attributable to its only temporary difference of $50,000,000 for estimated expenses. At the end
of the current year, the temporary difference is $45,000,000. At the beginning of the year there
was no valuation account for the deferred tax asset. At year-end, World Industries now
estimates that it is more likely than not that one-third of the deferred tax asset will never be
realized. Taxable income is $12,000,000 for the current year and the tax rate is 30% for all
years.
Required:
Prepare journal entries to record World Industries’ income tax expense for the current year.
Show well-labeled supporting computations for each component of the journal entries.
133. At the end of the prior year, Doubtful Inc. had a deferred tax asset of $20,000,000 attributable
to its only timing difference, a temporary difference of $50,000,000 in a liability for estimated
expenses. At that time, a valuation allowance of $4,000,000 was established. At the end of the