Spreadsheet Assignment Using the information from the case bekow develop a Sprea

Question

Spreadsheet Assignment Using the information from the case bekow develop a Spreadsheet to find income tax expense and net THE CASE Quark Donut Company was incorporatod (as a C corporation) and startod business in 2007, make and sell donuts. Quark remted space in a local mall with a 8 year operating lease. Quark's only capital expenditure was the purchase in January of 2007 of equipment at a cost of $280,000. This equipment has an economic life of 8 years and 0 expectod salvage valuc. Quark uses straight line depreciation for computation of GAAP net income because this best reflects the true economic depecciation of the equipment. For income tax purposes Quark is permitted to use MACRS (the modified accelerated cost recovery system), and the equipment is considered to be in the 7 year class. Therefore the allowved MA0RStates are 14.29% the first year. 24Ay% the second year, 17.49% the third year, 12.499, the fourth year 8.93% the fifth year. 8.92% in the sixth 893%the seventh year and 446% tthc 8th year. Depreciation is the only non-cash cxpense, and is the only source of a difference betwon taxable income and financial accounting income before tax. Assume an income tax rate of 35% is enacted for the years 2007-2009. During the year 2010 a new income tax rate of 30% was enacted for 2010 to 2014. Projected revenues and opcrating expenses (excluding taxes and depreciation)ae as follows: Year Revenues Expenses $130,000 I80,000 $185,000 190,000 $100,000 110,000 $113,000 16,000 Year Revenues Expenses $195,000 $200,000 $200,000 200,000 $127,000 S132,000 $135,000 $138,000 . Use a spreadsheet to find: (note your spreadsheet is the answer to part a. income taxes paid that yancurment income tax payabc) b. deferred tax liability c. the change in deferred tax liability (equal to deferred income tax conse) d. totl income tax expense, II. Using the numbers from your sprcadsheet hand wrise the coroct joumal cnary o income taxes for the year 2010. 111. Find the effective tax rate for 2010 and explain why the enotns tax rate for 2010 is not 30% IV. Assuming the straight line method yields the true economie deprociation what is the advantages of being able to use MACRS for income tax determinations? Why are tax effects important in dociding whether this is a good investment? 2 012 23204

Explanation / Answer

Accounting Income 2007 2008 2009 2010 2011 2012 2013 2014 Revenues 150000 180000 185000 190000 195000 200000 200000 200000 Expenses 100000 110000 113000 116000 127000 132000 135000 138000 less depreciation Straight line 35000 35000 35000 35000 35000 35000 35000 35000 Income before taxes 15000 35000 37000 39000 33000 33000 30000 27000 less taxes 5250 12250 12950 11700 9900 9900 9000 8100 Net Income 9750 22750 24050 27300 23100 23100 21000 18900 Taxable Income 2007 2008 2009 2010 2011 2012 2013 2014 Revenues 150000 180000 185000 190000 195000 200000 200000 200000 Expenses 100000 110000 113000 116000 127000 132000 135000 138000 less MACRS Depreciation 40012 68572 48972 34972 25004 25004 24976 12488 280000 Total Value of Asset Income before taxes 9988 1428 23028 39028 42996 42996 40024 49512 less taxes 3496 500 8060 11708 12899 12899 12007 14854 Net Income 6492 928 14968 27320 30097 30097 28017 34658 Solution (i) a 2007 2008 2009 2010 2011 2012 2013 2014 Current Income taxes Payable $          3,496 $             500 $          8,060 $       11,708 $       12,899 $       12,899 $       12,007 $       14,854 b Deferred Tax liability balance $          1,754 $        13,504 $       18,395 $       15,758 $       12,759 $          9,760 $          6,753 $                (0) c Change in Deferred tax liability $          1,754 $        11,750 $          4,890 $        (2,637) $        (2,999) $        (2,999) $        (3,007) $        (6,754) d income tax expense $          5,250 $        12,250 $       12,950 $          9,072 $          9,900 $          9,900 $          9,000 $          8,100 e net income $          9,750 $        22,750 $       24,050 $       27,300 $       23,100 $       23,100 $       21,000 $       18,900 Balance up to 2009 at 35% $       18,395 Balance up to 2009 at 30% $       15,767 Balance adjustment in 2010 $          2,628 Solution (ii) Debit Credit Income Taxes Expense $          9,072 Deferred Tax Liability $          2,637 Income Tax payable $        11,709 rounding error for $1 Solution (iii) Effective tax rate for 2010 9072/37000 24.52% Because the adjustment in deferred tax for the previous rate of 35% and current rate of 30% amounted to around $2628. Solution (iv) The method which is allowed by the tax authority is important and it is relevant as the tax in cash to be paid using the depreciation allowed by tax authority and in this case the MACRS is allowed, if the straight line would have been allowed then there would be no deferred tax and the payment of tax in cash would be equal to tax expense. And in all investment decision the cash flow is considered and the depreciation method allowed by tax authority has an impact on cash flow therefore from investment point of view the MACRS is allowed therefore it is to be considered relevant.

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