On January 1, 2017, Abbey acquires 90 percent of Benjamin\'s outstanding shares.

Question

On January 1, 2017, Abbey acquires 90 percent of Benjamin's outstanding shares. Financial information for these two companies for the years of 2017 and 2018 follows:

Assume that a tax rate of 40 percent is applicable to both companies.

a. On consolidated financial statements for 2018, what are the income tax expense and the income tax currently payable if Abbey and Benjamin file a consolidated tax return as an affiliated group?

b. On consolidated financial statements for 2018, what are the income tax expense and income tax currently payable if they choose to file separate returns?

2017 2018 Abbey Company: Sales $ (742,000 ) $ (994,000 ) Operating expenses 512,000 564,000 Intra-entity gross profits in ending inventory (included in above figures) (185,000 ) (232,000 ) Dividend income—Benjamin Company (22,500 ) (27,000 ) Benjamin Company: Sales (237,000 ) (279,000 ) Operating expenses 128,000 162,000 Dividends paid (25,000 ) (30,000 )

Explanation / Answer

a. Income tax expense and Income tax currently payable if consolidated tax return if filed

There is no need to make deferred tax as -

1) Abbey and Benjamin have filed a consolidated return and they have deferred the unrealized inventory profit for both tax purpose and financial purpose so there are no temporary differences. Therefore the income tax expense would also be $200000.

2) The dividends paid by Abbey and Benjamin are not taxable because Abbey holds 90% of the outstanding shares. Hence they are not relevant as they are filing a consolidated return.

Hence, the income tax payable and income tax expense in consolidated tax return will be $200000.

b. Income tax expense and Income tax currently payable if separate tax return if filed.

On its separate tax return, Abbey will report taxable income of $430000 (Sales less operating expenses)-- the unrealized gains cannot be deferred. The dividends would not be taxable because Benjamin still meets the criteria to be a member of an affiliated group. A consolidate return is not a requirement for these dividends to be excluded. Thus, income taxes payable by Abbey would be $172000 ( $430000 x 40% ).

For calculation of the income tax expense for Abbey, the two temporary differences must be considered:

Taxable Income $430000

Gain taxed in 2017 although realized in 2018 $185000

Gain taxed in 2018 although not yet realized ($232000)

2018 realized income subject to taxation $ 383000

Tax Rate 40%

Income Tax Expense $ 153200

The $ 18800 difference between the inome tax payable and the income tax expense is the tax effect on the net unrealized gain ($47000 x 40%).

Benjamin will have an expense and payable of $ 46800 ($117000 x 40%).

Consolidated Income Tax Expense is $ 200000 ( $153200+46800)

Consolidated Income Tax Payable is $ 218800 ( $172000 + 46800)

Particulars Abbey Benjamin Consolidated Income Sales 994000 279000 1273000 (-) Operating Expenses 564000 162000 726000 Net Profit 430000 117000 547000 (+) Unrealiazed Gross Profit for the year 2017 185000 (-) Unrealiazed Gross Profit for the year 2018 232000 Net Taxable Income 500000 Tax Rate 40% Income Tax Payable 200000

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