CHAPTER 19

Accounting for Income Taxes

Level of Time
Item Description Difficulty (minutes)
E19-3 One temporary difference, future taxable amounts, one rate, Simple 15–20
beginning deferred taxes.
E19-5 Two temporary differences, one rate, beginning deferred taxes. Simple 15–20
E19-6 Identify temporary or permanent differences. Simple 10–15
E19-8 Two temporary differences, one rate, 3 years. Simple 10–15
E19-11 Three differences, classify deferred taxes. Simple 10–15
E19-14 Deferred tax asset with and without valuation account. Moderate 20–25
E19-15 Deferred tax asset with previous valuation account. Complex 20–25
E19-19 Two differences, one rate, beginning deferred balance, compute Complex 25–30
pretax financial income.
E19-23 NOL carryback and carryforward, valuation account versus no Complex 30–35
valuation account.
P19-1 Three differences, no beginning deferred taxes, multiple rates. Complex 40–45
P19-5 NOL without valuation account. Simple 20–25
P19-8 Two differences, 2 years, compute taxable income and pretax Complex 40–50
financial income.
P19-9 Five differences, compute taxable income and deferred taxes, Complex 40–50
draft income statement.
EXERCISE 19-3 (15–20 minutes)

(a) Taxable income for 2010........................................... $400,000

Enacted tax rate........................................................ 40%
Income tax payable for 2010..................................... $160,000

(b) Future Years

2011 2012 Total
Future taxable (deductible) amounts $175,000 $175,000 $350,000
Tax Rate 40% 40%
Deferred tax liability (asset) $ 70,000 $ 70,000 $140,000
Deferred tax liability at the end of 2010........................... $140,000
Deferred tax liability at the beginning of 2010........... 90,000
Deferred tax expense for 2010 (increase
required in deferred tax liability)............................ 50,000
Current tax expense for 2010................................... 160,000
Income tax expense for 2010................................... $210,000

Income Tax Expense................................................ 210,000

Income Tax Payable......................................
160,000
Deferred Tax Liability..................................... 50,000

(c) Income before income taxes....................................

$525,000
Income tax expense
Current.......................................................... $160,000
Deferred........................................................ 50,000
210,000
Net income...............................................................
$315,000

Note to instructor: Because of the flat tax rate for all years, the amount of
cumulative temporary difference existing at the beginning of the year can
be calculated by dividing $90,000 by 40%, which equals $225,000. The
difference between the $225,000 cumulative temporary difference at the
beginning of 2010 and the $350,000 cumulative temporary difference at the
end of 2010 represents the net amount of temporary difference originating
during 2010 (which is $125,000). With this information, we can reconcile
pretax financial income with taxable income as follows:
 Pretax financial income.............................................................
$525,000
Temporary difference originating giving rise
to net future taxable amounts.........................................
(125,000)
Taxable income..................................................................
$400,000
EXERCISE 19-5 (15–20 minutes)

(a) Taxable income.......................................................... $115,000

Enacted tax rate.......................................................... 40%
Income tax payable..................................................... $ 46,000

(b) Income Tax Expense.................................................. 80,000

Deferred Tax Asset..................................................... 14,000
Income Tax Payable............................................
46,000
Deferred Tax Liability...........................................
48,000

Temporary Future Taxable Tax Deferred Tax

Difference (Deductible) Amounts Rate (Asset) Liability
First one ($220,000 40% $88,000
Second one ( (35,000) 40% $(14,000)              
Totals $185,000 $(14,000) $88,000

*Because of a flat tax rate, these totals can be reconciled: $185,000 X

40% = $(14,000) + $88,000.
Deferred tax liability at the end of 2010..................................... $
88,000
Deferred tax liability at the beginning of 2010...........................
40,000
Deferred tax expense for 2010 (increase
required in deferred tax liability)............................................ $
48,000
Deferred tax asset at the end of 2010.......................................
$(14,000
Deferred tax asset at the beginning of 2010.............................
0
 Deferred tax benefit for 2010 (increase
required in deferred tax asset)..............................................
$(14,000)
Deferred tax expense for 2010................................................. $
48,000
Deferred tax benefit for 2010....................................................
(14,000)
Net deferred tax benefit for 2010.............................................. 34,000
Current tax expense for 2010 (Income tax payable).................
46,000
Income tax expense for 2010.................................................... $
80,000

(c) Income before income taxes.................................... $200,000

Income tax expense
Current.............................................................. $46,000
Deferred............................................................ 34,000
80,000
Net income............................................................... $120,000
EXERCISE 19-5 (Continued)
Note: The details on the current/deferred tax expense can be disclosed in the notes to the
financial statements.

Note to instructor: Because of the flat tax rate for all years, the amount of
cumulative temporary difference existing at the beginning of the year
can be calculated by dividing the $40,000 balance in Deferred Tax
Liability by 40%, which equals $100,000. This information may now be
combined with the other facts given in the exercise to reconcile pretax
financial income with taxable income as follows:
Pretax financial income.............................................................
$200,000
Net originating temporary difference
giving rise to future taxable amounts
($220,000 – $100,000)..........................................................
(120,000)
Originating temporary difference giving
rise to future deductible amounts..........................................
35,000
Taxable income.........................................................................
$115,000
EXERCISE 19-6 (10–15 minutes)
(a) (2) (e) (2) (i)
(3)*
(b) (1) (f) (3) (j)
(1)
(c) (3) (g) (2) (k)
(1)
(d) (1) (h) (3)
*When the cost method is used for financial reporting purposes, the
dividends are recognized in the income statement in the period they are
received, which is the same period they be must be reported on the tax
return. However, depending on the level of ownership by the investor, 70%
or 80% of the dividends received from other U.S. corporations may be ex-
cluded from taxation because of a “dividends received deduction.” These
tax-exempt dividends create a permanent difference.

EXERCISE 19-8 (10–15 minutes)

(a) 2010
Income Tax Expense.......................................... 336,000
Deferred Tax Asset ($20,000 X 40%)................. 8,000
Deferred Tax Liability ($30,000 X 40%)........ 12,000
Income Tax Payable ($830,000 X 40%).......
332,000

2011
Income Tax Expense......................................... 364,000
Deferred Tax Asset ($10,000 X 40%)................ 4,000
Deferred Tax Liability ($40,000 X 40%)........ 16,000
 Income Tax Payable ($880,000 X 40%).......
352,000

2012
Income Tax Expense......................................... 378,000
Deferred Tax Asset ($8,000 X 40%).................. 3,200
Deferred Tax Liability ($20,000 X 40%)........ 8,000
Income Tax Payable ($933,000 X 40%).......
373,200

(b) Current assets

Deferred tax asset ($8,000 + $4,000 + $3,200).................. $15,200
Long-term liabilities
Deferred tax liability ($12,000 + $16,000 + $8,000)............ $36,000

The warranty is classified as current because the related liability is

current.

The deferred tax liability is noncurrent because the related asset is

noncurrent.

(c) Pretax financial income............................................ $945,000

Income tax expense
Current................................................................ $373,200
Deferred ($8,000 – $3,200)................................. 4,800
378,000
Net Income..............................................................
$567,000

Note: The details on the current/deferred tax expense can be disclosed in

the notes to the financial statements.
EXERCISE 19-11 (10–15 minutes)

Resulting
Deferred Tax Related Balance Sheet
Temporary Difference (Asset) Liability Account Classification
Depreciation $200,000 Plant Assets Noncurrent
Lawsuit obligation $(50,000) Lawsuit Obligation Current
Installment sale 48,000* Installment Receivable Current
Installment sale   252,000** Installment Receivable Noncurrent
 Totals $(50,000) $500,000

*$120,000 X 40% = $48,000 **$300,000 – $48,000 = $252,000

Current assets
Deferred tax asset ($50,000 – $48,000)................................... $
2,000

Long-term liabilities
Deferred tax liability ($200,000 + $252,000) 452,000

EXERCISE 19-14 (20–25 minutes)

(a) Income Tax Expense................................................. 290,000

Deferred Tax Asset.................................................... 50,000
Income Tax Payable..........................................
340,000

Taxable income.........................................................
$850,000
Enacted tax rate........................................................
40%
Income tax payable...................................................
$340,000

Cumulative Future Taxable Deferred Tax

Date (Deductible) Amounts Tax Rate (Asset) Liability
12/31/11 $(500,000) 40% $(200,000)

Deferred tax asset at the end of 2011..............................................

$200,000
Deferred tax asset at the beginning of 2011.............................
150,000
Deferred tax benefit for 2011 (increase in
deferred tax asset)................................................................
(50,000)
Current tax expense for 2011 (Income tax payable).................
340,000
Income tax expense for 2011....................................................
$290,000
EXERCISE 19-14 (Continued)
(b) The journal entry at the end of 2011 to establish a valuation account:

Income Tax Expense................................................. 30,000

Allowance to Reduce Deferred Tax Asset
to Expected Realizable Value........................ 30,000

Note to instructor: Although not requested by the instructions, the

pretax financial income can be computed by completing the following
reconciliation:

Pretax financial income for 2011............................................... $ X

Originating difference which will result
in future deductible amounts.................................................
a
125,000
Taxable income for 2011..........................................................
$850,000

Solving for pretax financial income:

X + $125,000 = $850,000
X = $725,000 = Pretax financial income
a
$500,000 – $375,000 = $125,000

EXERCISE 19-15 (20–25 minutes)

(a) Income Tax Expense................................................. 290,000

Deferred Tax Asset.................................................... 50,000
Income Tax Payable..........................................
340,000

Allowance to Reduce Deferred Tax Asset

to Expected Realizable Value................................ 40,000
Income Tax Expense.........................................
40,000

Taxable income......................................................... $850,000

Enacted tax rate........................................................
40%
Income tax payable $340,000
EXERCISE 19-15 (Continued)
Cumulative Future Taxable Deferred Tax
Date (Deductible) Amounts Tax Rate (Asset) Liability
12/31/11 $(500,000) 40% $(200,000)

Deferred tax asset at the end of 2011.......................................

$200,000
Deferred tax asset at the beginning of 2011.............................
150,000
Deferred tax benefit for 2011 (increase in
deferred tax asset)................................................................
(50,000)
Current tax expense for 2011 (Income tax payable).................
340,000
Income tax expense for 2011....................................................
$290,000

Valuation account needed at the end of 2011........................... $

0
Valuation account balance at the beginning of 2011................
40,000
Reduction in valuation account during 2011............................. $
40,000

(b) Income Tax Expense................................................. 290,000

Deferred Tax Asset.................................................... 50,000
Income Tax Payable..........................................
340,000

Income Tax Expense................................................. 160,000

Allowance to Reduce Deferred Tax Asset
to Expected Realizable Value........................
160,000
 Taxable income......................................................... $850,000
Enacted tax rate.........................................................
40%
Income tax payable.................................................... $340,000

Cumulative Future Taxable Deferred Tax

Date (Deductible) Amounts Tax Rate (Asset) Liability
12/31/11 $(500,000) 40% $(200,000)

Deferred tax asset at the end of 2011.......................................

$200,000
Deferred tax asset at the beginning of 2011.............................
150,000
Deferred tax benefit for 2011 (increase in
deferred tax asset)................................................................
(50,000)
Current tax expense for 2011 (Income tax payable).................
340,000
Income tax expense for 2011....................................................
$290,000

EXERCISE 19-15 (Continued)

Valuation account needed at the end of 2011......................... $200,000

Valuation account balance at the beginning of 2011............... 40,000
Increase in valuation account during 2011.............................. $160,000

Note to instructor: Although not requested by the instructions, the

pretax financial income can be computed by completing the following
reconciliation:

Pretax financial income for 2011.............................................. $ X

Originating difference which will result in future
deductible amounts..............................................................
a
125,000
Taxable income for 2011.........................................................
$850,000

Solving for pretax financial income:

 X + $125,000 = $850,000
X = $725,000 = Pretax financial income
a
$500,000 – $375,000 = $125,000.
EXERCISE 19-19 (25–30 minutes)

(a) (All figures are in millions.)

Resulting
Temporary Deferred Tax Related Balance
Difference Rate (Asset) Liability Sheet Account Classification

$90 million estimated

costs per books 40% $(36) Estimated Payable Current
$50 million excess
depreciation per tax 40%       $20 Plant Assets Noncurrent
Totals $(36) $20
(b) Current assets
Deferred tax asset........................................................
$36,000,000

Long-term liabilities
Deferred tax liability......................................................
$20,000,000
2
(c) Income before income taxes........................ $95,000,000
Income tax expense
1
Current................................................. $64,000,000
3
Deferred............................................... (26,000,000)
4
38,000,000
Net income................................................... $57,000,000
1
Taxable income for 2010.....................................................
$160,000,000
Enacted tax rate.................................................................. 40%
Income tax payable for 2010............................................... $
64,000,000
2
$10,000,000 ÷ 40% = $25,000,000 cumulative taxable temporary
difference at the beginning of 2010.
Cumulative taxable temporary difference
at the end of 2010...........................................................
$50,000,000
Cumulative taxable temporary difference
at the beginning of 2010..................................................
25,000,000
Taxable temporary difference originating
 during 2010.....................................................................
$25,000,000
Cumulative deductible temporary difference
at the end of 2010...........................................................
$90,000,000
Cumulative deductible temporary difference
at the beginning of 2010..................................................
0
Deductible temporary difference originating during 2010....
$90,000,000
EXERCISE 19-23 (30–35 minutes)

(a) 2009
Income Tax Expense.................................................... 37,400
Income Tax Payable ($110,000 X 34%)...............
37,400

2010

Income Tax Expense................................................. 30,600

Income Tax Payable ($90,000 X 34%)............... 30,600

2011

Income Tax Refund Receivable................................. 68,000

Deferred Tax Asset.................................................... 22,800
Benefit Due to Loss Carryback..........................
68,000**
Benefit Due to Loss Carryforward......................
22,800**

**[34% X $(110,000)] + [34% X $(90,000)] = $68,000

**38% X ($260,000 – $110,000 – $90,000) = $22,800

2012

Income Tax Expense................................................. 83,600

Income Tax Payable..........................................
60,800*
Deferred Tax Asset............................................ 22,800
 *[($220,000 – $60,000) X 38%]

(b) Operating loss before income taxes.......................... $(260,000)

Income tax benefit
Benefit due to loss carryback............................. $68,000
Benefit due to loss carryforward........................ 22,800
90,800
Net loss...................................................................... $(169,200)

(c) 2011
Income Tax Refund Receivable................................. 68,000
Deferred Tax Asset.................................................... 22,800
Benefit Due to Loss Carryback..........................
68,000*
Benefit Due to Loss Carryforward......................
22,800**

**[34% X $(110,000)] + [34% X $(90,000)] = $68,000

**38% X ($260,000 – $110,000 – $90,000) = $22,800

PROBLEM 19-1

(a) X(.40) = $320,000 taxes due for 2010

X = $320,000 ÷ .40
X = $800,000 taxable income for 2010

(b) Taxable income [from part (a)]............................................... $800,000

Excess depreciation............................................................... 120,000
Municipal interest................................................................... 10,000
Unearned rent........................................................................ (40,000)
Pretax financial income for 2010.................................... $890,000

(c) 2010
Income Tax Expense
($320,000 + $42,000 – $14,000)............................. 348,000
Deferred Tax Asset ($40,000 X .35)............................ 14,000
Income Tax Payable ($800,000 X .40)................
320,000
Deferred Tax Liability ($120,000 X .35)...............
42,000
 2011
Income Tax Expense
($343,000 + $7,000 – $10,500)............................... 339,500
Deferred Tax Liability [($120,000 ÷ 4) X .35]............... 10,500
Income Tax Payable ($980,000 X .35)................
343,000
Deferred Tax Asset [($40,000 ÷ 2) X .35]............
7,000

(d) Income before income taxes.......................................

$890,000
Income tax expense
Current................................................................. $320,000
Deferred ($42,000 – $14,000)............................. 28,000
348,000
Net income..................................................................
$542,000
 PROBLEM 19-5

(a) 2010

Income Tax Refund Receivable

 [($50,000 X 30%) + ($80,000 X 40%)]...................... 47,000
Benefit Due to Loss Carryback.............................
47,000

Deferred Tax Asset....................................................... 20,000

Benefit Due to Loss Carryforward
($180,000 – $50,000 – $80,000 = $50,000)
($50,000 X 40% = $20,000)..............................
20,000

2011

Income Tax Expense.................................................... 28,000

Deferred Tax Asset...............................................
20,000
Income Tax Payable
[($70,000 – $50,000) X 40%]............................ 8,000

2012

Income Tax Expense.................................................... 35,000

Income Tax Payable ($100,000 X 35%)...............
35,000

(b) The income tax refund receivable account totaling $47,000 will be
reported under current assets on the balance sheet at December 31,
2010. This type of receivable is usually listed immediately above
inventory in the current assets section. This receivable is normally
collectible within two months of filing the amended tax returns reflecting
the carryback. A deferred tax asset of $20,000 should also be classified
as a current asset because the benefits of the loss carryforward are
expected to be realized in the year that immediately follows the loss
year which means the benefits are expected to be realized in 2011. A
current deferred tax asset is usually listed at or near the end of the list of
current assets on the balance sheet. Also, retained earnings is
 increased by $67,000 ($47,000 + $20,000) as a result of the entries to
record the benefits of the loss carryback and the loss carryforward.

PROBLEM 19-5 (Continued)

(c) 2010 Income Statement

Operating loss before income taxes..................

$(180,000)
Income tax benefit
Benefit due to loss carryback..................... $47,000
Benefit due to loss carryforward................. 20,000
67,000
Net loss.............................................................. $(113,000)

(d) 2011 Income Statement

Income before income taxes..............................

$70,000
Income tax expense
a
Current....................................................... $ 8,000
Deferred..................................................... 20,000
28,000
Net income.........................................................
$42,000
a
Loss (2010)......................................................................... ($180,000)
Loss carryback (2008)........................................................ 50,000
Loss carryback (2009) ....................................................... 80,000
Loss carryforward (2011) ................................................... (50,000)
Taxable income 2011 before carryforward......................... 70,000
Taxable income 2011......................................................... 20,000
Enacted tax rate for 2011....................................................
40%
Income tax payable for 2011......................................... $ 8,000
 PROBLEM 19-8
a)
Temporary Future Taxable Tax Deferred Tax
Difference (Deductible) Amounts Rate (Asset) Liability
Depreciation $(60,000)* 40% $(24,000)
*(Computation shown on next page.)
Other assets (noncurrent)
Deferred tax asset..............................................................
$24,000
This answer may differ from what is expected. Usually, depreciation is
faster for tax purposes; in this situation, there is excess depreciation
for book purposes in the first year for depreciation (2010).
(b) Income Tax Expense............................................... 106,000
Deferred Tax Asset.................................................. 24,000
Income Tax Payable.........................................
130,000
$130,000 taxes due for 2010 ÷ 40% 2010 tax rate = $325,000 taxable
income for 2010.
Taxable income for 2010...........................................................
$325,000
Tax rate......................................................................................
40%
Income tax payable for 2010 (also given data)..........................
$130,000
Deferred tax asset at the end of 2010........................................ $
24,000
Deferred tax asset at the beginning of 2010..............................
0
Deferred tax benefit for 2010 (increase in
deferred tax asset).................................................................
(24,000)
Current tax expense for 2010 (Income tax payable)..................
130,000
Income tax expense for 2010.....................................................
$106,000
 a
(c) Income before income taxes.................................... $265,000
Income tax expense
Current............................................................. $130,000
Deferred........................................................... (24,000)
106,000
Net income............................................................... $159,000
a
Pretax financial income............................................................. $ X
Excess depreciation per books..................................................
b
60,000
Taxable income [from (b) above]...............................................
$325,000
Solving for X; X + $60,000 = $325,000; X = $265,000 pretax financial income.
PROBLEM 19-8 (Continued)
b b
Book Depreciation Tax Depreciation Difference
2010 $120,000 $ 60,000* ($60,000
2011 120,000 120,000 0
2012 120,000 120,000 0
2013 120,000 120,000 0
2014 120,000 120,000 0
2015 0 60,000 ( (60,000)
Totals $600,000 $600,000 ($ 0

*($600,000 ÷ 5) X .5

(d)
Temporary Future Taxable Tax Deferred Tax
Difference (Deductible) Amounts Rate (Asset) Liability
Depreciation $ (60,000) 40% $(24,000)
Unearned rent (75,000) 40% (30,000)
Unearned rent (75,000) 40% (30,000)
Totals $(210,000) $(84,000)

Temporary Resulting Deferred Tax Related Balance Sheet

Difference (Asset) Liability Account Classification

Depreciation $(24,000) Plant Assets Noncurrent

Unearned rent (30,000) Unearned Rent Current
Unearned rent (30,000) Unearned Rent Noncurrent
 Totals $(84,000)

Current assets
Deferred tax asset..............................................................
$30,000

Other assets (noncurrent)

Deferred tax asset..............................................................
c
$54,000
c
$30,000 + $24,000 = $54,000

PROBLEM 19-8 (Continued)

(e) Income Tax Expense................................................. 44,000

Deferred Tax Asset.................................................... 60,000
Income Tax Payable..........................................
104,000

$104,000 taxes due for 2011 ÷ 40% 2011 tax rate = $260,000 taxable
income for 2011.

Taxable income for 2011...........................................................

$260,000
Tax rate for 2011........................................................................
40%
Income tax payable for 2011 (also given data)..........................
$104,000

Deferred tax asset at the end of 2011........................................ $

84,000
Deferred tax asset at the beginning of 2011..............................
24,000
Deferred tax benefit for 2011 (increase in
deferred tax asset)................................................................. $
(60,000)
 Deferred tax benefit for 2011..................................................... $
(60,000)
Current tax expense for 2011 (Income tax payable)..................
104,000
Income tax expense for 2011..................................................... $
44,000
d
(f) Income before income taxes...................................... $110,000
Income tax expense
Current............................................................... $104,000
Deferred............................................................. (60,000)
44,000
Net income................................................................ $ 66,000
d
Pretax financial income............................................................. $ X
Excess rent collected over rent earned.....................................
150,000
Taxable income [from (e) above]...............................................
$260,000

Solving for X:
X + $150,000 = $260,000
X = $110,000 pretax financial income.
 PROBLEM 19-9

(a) Pretax financial income..............................................................

$100,000
Permanent differences:
Fine for pollution................................................................. 3,500
Tax-exempt interest........................................................... (1,500)
Originating temporary differences:
Excess warranty expense per books
($7,000 – $2,000)........................................................... 5,000
Excess construction profits per books
($92,000 – $67,000).......................................................
(25,000)
Excess depreciation per tax return
($80,000 – $60,000).......................................................
(20,000)
Taxable income.......................................................................... $
62,000

(b)
Temporary Future Taxable Tax Deferred Tax
Difference (Deductible) Amounts Rate (Asset) Liability
Warranty costs $ (5,000) 40% $(2,000)
Construction profits 25,000 40% $10,000
Depreciation ( 20,000 40%              * 8,000
Totals ($40,000 $(2,000) *$18,000*

*Because of a flat tax rate, these totals can be reconciled: $40,000 X

40% = $(2,000) + $18,000.

(c) Income Tax Expense.................................................. 40,800

Deferred Tax Asset..................................................... 2,000
Deferred Tax Liability...........................................
18,000
Income Tax Payable............................................
24,800
 Taxable income for 2011 [answer part (a)]................................
$62,000
Tax rate......................................................................................
40%
Income tax payable for 2011......................................................
$24,800

Deferred tax liability at the end of 2011 [part (b)].......................

$18,000
Deferred tax liability at the beginning of 2011............................
0
Deferred tax expense for 2011 $18,000

PROBLEM 19-9 (Continued)

Deferred tax asset at the end of 2011........................................ $

2,000
Deferred tax asset at the beginning of 2011..............................
0
Deferred tax benefit for 2011..................................................... $
(2,000)

Deferred tax expense for 2011..................................................

$18,000
Deferred tax benefit for 2011.....................................................
(2,000)
Net deferred tax expense for 2011............................................
$16,000

Current tax expense for 2011 (Income tax payable)..................

$24,800
Deferred tax expense for 2011..................................................
16,000
Income tax expense for 2011.....................................................
$40,800

(d) Income before income taxes...................................... $100,000

Income tax expense
Current............................................................... $24,800
 Deferred............................................................. 16,000
40,800
Net income........................................................................ $
59,200