The differences between the book basis and tax basis of the assets and liabilities of Castle Corporation at the end of 2008 are presented below. � It is estimated that the litigation liability will be settled in 2009. The difference in accounts receivable will result in taxable amounts of $30,000 in 2009 and $20,000 in 2010. The company has taxable income of $350,000 in 2008 and is expected to have taxable income in each of the following 2 years. Its enacted tax rate is 34% for all years. This is the company’s first year of operations. The operating cycle of the business is 2 years. Instructions (a) Prepare the journal entry to record income tax expense, deferred income taxes, and income tax payable for 2008. (b) Indicate how deferred income taxes will be reported on the balance sheet at the end of2008.
To prepare the journal entry to record income tax expense, deferred income taxes, and income tax payable for 2008, we need to consider the differences between the book basis and tax basis of the assets and liabilities of Castle Corporation.
(a) First, let's calculate the temporary differences that will result in deferred tax assets or liabilities:
1. Litigation liability:
The estimated settlement of the litigation liability in 2009 will create a temporary difference. As it is not deductible for tax purposes until settled, this will result in a taxable temporary difference. The tax amount for 2009 will be $30,000, and for 2010 will be $20,000.
2. Accounts receivable:
The difference in accounts receivable will also result in a temporary difference. Since the taxable amount is deferred to future years, this will create a deductible temporary difference.
Now, let's calculate the deferred tax liability and deferred tax asset:
Deferred tax liability:
Taxable temporary difference (litigation liability):
$30,000 x 34% = $10,200 (for 2009)
$20,000 x 34% = $6,800 (for 2010)
Deferred tax asset:
Deductible temporary difference (accounts receivable):
$30,000 x 34% = $10,200 (for 2009)
$20,000 x 34% = $6,800 (for 2010)
Now, we can prepare the journal entry:
Income tax expense: $350,000 x 34% = $119,000
Deferred income taxes (liability): $10,200 (for 2009)
Deferred income taxes (asset): $10,200 (for 2009)
Income tax payable: $119,000 - $10,200 (liability) = $108,800
The journal entry would be:
Income Tax Expense $119,000
Deferred Income Taxes $10,200
Income Tax Payable $108,800
(b) The deferred income taxes will be reported on the balance sheet at the end of 2008 as follows:
Deferred Tax Assets:
- Accounts Receivable: $10,200 (for 2009)
Deferred Tax Liabilities:
- Litigation Liability: $10,200 (for 2009)
Note: Deferred income taxes represent the future tax consequences of temporary differences between book and tax accounting. The deferred tax asset (-) or liability (+) represents the expected future tax benefits or obligations.