California Surplus Inc. qualifies to use the installment-sales method for tax pu

Question

California Surplus Inc. qualifies to use the installment-sales method for tax purposes and sold an investment on an installment basis. The total gain of $75000 was reported for financial reporting purposes in the period of sale. The installment period is 3 years; one-third of the sale price is collected in 2014 and the rest in 2015 and 2016. The tax rate was 35% in 2012, 30% in 2013, and 30% in 2014. The enacted tax rates of 2013 and 2014 are not known until 2013. The accounting and tax data are shown below. Financial Accounting Tax Return 2014 (35% tax rate) Income before temporary difference $ 175,000 $ 175,000 Temporary difference $ 75,000 $ 25,000 Income $ 250,000 $ 200,000 2015 (30% tax rate) Income before temporary difference $ 200,000 $ 200,000 Temporary difference $ - $ 25,000 Income $ 200,000 $ 225,000 2016 (30% tax rate) Income before temporary difference $ 180,000 $ 180,000 Temporary difference $ - $ 25,000 Income $ 180,000 $ 205,000 Required: 1) Prepare the journal entries to record the income tax expense, deferred income taxes, and the income taxes payable for 2014, 2015, and 2016. No deferred income taxes existed at the beginning of 2012. 2) Explain how the deferred taxes will appear on the balance sheet at the end of each year. (Assume Installment Accounts Receivable is classified as a current asset.) 3) Show the income tax expense section of the income statement for each year, beginning with “Income before income taxes.”

Explanation / Answer

Part 1)

We need to determine the cumulative temporary difference at the end of each year before we arrive at the amount of deferred taxes.

The statement of cumulative temporary difference is given below:

__________

Journal Entries are given below:

______________

Part 2)

Balance Sheet for the Year 2014:

______

Balance Sheet for the Year 2015:

______

Balance Sheet for the Year 2016:

No deferred tax liability will be reported for the Year 2016.

__________

Part 3)

2014:

______

2015:

______

2016:

2014 2015 2016 Pretax Financial Income 250,000 200,000 180,000 Taxable Income 200,000 225,000 205,000 Temporary Difference 50,000 -25,000 -25,000 Cumulative Temporary Difference as at 1st January 0 50,000 25,000 Cumulative Temporary Difference as at 31st December 50,000 25,000 0 Deferred Tax Liability 17,500 7,500 0

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