Sherrod, Inc., reported pretax accounting income of $89 million for 2006. The following information relates to differences between pretax accounting income and taxable income:
Income from installment sales of properties included in pretax accounting income in 2006 exceeded that reported for tax purposes by $3 million. The installment receivable account at year-end had a balance of $4 million (representing portions of 2005 and 2006 installment sales), expected to be collected equally in 2007 and 2008.
Sherrod was assessed a penalty of $2 million by the Environmental Protection Agency for violation of a federal law in 2006. The fine is to be paid in equal amounts in 2006 and 2007.
Sherrod rents its operating facilities but owns one asset acquired in 2005 at a cost of $79 million. Depreciation is reported by the straight-line method assuming a four-year useful life. On the tax return, deductions for depreciation will be more than straight-line depreciation the first two years but less than straight-line depreciation the next two years ($ in millions):
Income Statement Tax Return Difference
2005 $ 20 $ 27 $ (7 )
2006 20 35 ( 15 )
2007 20 12 8
2008 20 6 14
$ 80 $ 80 $ 0
Bad debt expense is reported using the allowance method, $3 million in 2006. For tax purposes, the expense is deducted when accounts prove uncollectible (the direct write-off method), $2 million in 2006. At December 31, 2006, the allowance for uncollectible accounts was $2 million (after adjusting entries). The balance was $1 million at the end of 2005 .
In 2006, Sherrod accrued an expense and related liability for estimated paid future absences of $5 million relating to the company's new paid vacation program. Future compensation will be deductible on the tax return when actually paid during the next two years ($2 million in 2007; $3 million in 2008).
During 2005, accounting income included an estimated loss of $2 million from having accrued a loss contingency. The loss is paid in 2006 at which time it is tax deductible.
Balances in the deferred tax asset and deferred tax liability accounts at January 1, 2006, were $1.2 million and $2.8 million, respectively. The enacted tax rate is 40% each year.
Required:
Determine the amounts necessary to record income taxes for 2006 and prepare the appropriate journal entry.
What is the 2006 net income?
Show how any deferred tax amounts should be classified and reported on the 2006 balance sheet.
is it possible that the cost of an asset can be less than the total depreciation? (in this case 79 is less than 80)
Well, well, well...it seems we have quite the accounting puzzle here. Let's see if we can clown around and find some answers for you!
To determine the net income for 2006, we need to factor in the differences between pretax accounting income and taxable income. Let's break it down:
1. Installment sales: The excess of $3 million in income from installment sales included in pretax accounting income should be subtracted since it is not reported for tax purposes.
2. EPA Penalty: The $2 million penalty assessed by the Environmental Protection Agency should be subtracted since it is an expense to Sherrod, Inc.
3. Depreciation: We have a bit of a funny situation here. While the deductions for depreciation on the tax return will be more in the first two years and less in the next two years, the total amount over the four years should balance out to $80 million. So, we don't need to adjust for depreciation in this case.
4. Bad debt expense: The difference between the allowance method ($3 million) and the direct write-off method ($2 million) should be added since it is a deduction for tax purposes.
5. Future absences: Since the future compensation will be deductible on the tax return when actually paid in 2007 and 2008, we don't need to adjust for this in 2006.
6. Accrued loss contingency: The estimated loss of $2 million from 2005, paid in 2006, should be added since it is tax deductible.
Now that we've sorted out all the adjustments, we can calculate the net income for 2006 by subtracting the adjusted differences from the pretax accounting income of $89 million.
As for the deferred tax amounts, they should be classified and reported on the 2006 balance sheet as follows: the deferred tax asset of $1.2 million and deferred tax liability of $2.8 million. These amounts represent the future tax benefits and obligations related to the timing differences between accounting income and taxable income.
And to answer your final question about the cost of an asset being less than the total depreciation, it's not something you see every day, but it can happen. In this case, the cost of the asset is indeed less than the total depreciation ($79 million compared to $80 million). It may be due to various factors such as changes in useful life, depreciation methods, or adjustments made for tax purposes. It's just one of those quirky accounting quirks!
I hope this clears things up for you. Remember, when it comes to accounting, it's always good to have a sense of humor. Happy clowning around with your numbers!
To determine the amounts necessary to record income taxes for 2006 and prepare the appropriate journal entry, we need to calculate the taxable income by adjusting the pretax accounting income for the differences provided:
1. Income from installment sales: The excess of income from installment sales for tax purposes is $3 million. Therefore, the taxable income should be increased by $3 million.
2. Environmental penalty: The penalty of $2 million assessed by the Environmental Protection Agency is not tax-deductible in the year incurred. Therefore, the taxable income should be increased by $2 million.
3. Differences in depreciation: We need to calculate the net difference between the depreciation reported in the income statement and the tax return for each year.
- In 2005, the difference is $27 million - $20 million = $7 million. The taxable income should be decreased by $7 million.
- In 2006, the difference is $35 million - $20 million = $15 million. The taxable income should be decreased by $15 million.
- In 2007, the difference is $12 million - $20 million = ($8) million. The taxable income should be increased by $8 million.
- In 2008, the difference is $6 million - $20 million = ($14) million. The taxable income should be increased by $14 million.
4. Bad debt expense: The allowance method is not allowed for tax purposes, so the $3 million expense is not deductible. The taxable income should be increased by $3 million.
5. Vacation accrual: The future compensation, amounting to $2 million in 2007 and $3 million in 2008, is not deductible until paid. Therefore, the taxable income should be increased by $5 million.
6. Loss contingency: The estimated loss of $2 million accrued in 2005 is deductible in 2006. Therefore, the taxable income should be decreased by $2 million.
Now we can calculate the taxable income:
Pretax accounting income: $89 million
Add:
- Income from installment sales: $3 million
- Environmental penalty: $2 million
Subtract:
- Depreciation difference 2005: ($7) million
- Depreciation difference 2006: ($15) million
- Depreciation difference 2007: $8 million
- Depreciation difference 2008: $14 million
- Bad debt expense: $3 million
- Vacation accrual: $5 million
- Loss contingency: ($2) million
Taxable income = $89 million + $3 million + $2 million - $7 million - $15 million + $8 million + $14 million + $3 million + $5 million - $2 million
Taxable income = $99 million
To record income taxes for 2006, we need to determine the income tax expense based on the taxable income and the enacted tax rate of 40%.
Income tax expense = Taxable income * Tax rate
Income tax expense = $99 million * 40%
Income tax expense = $39.6 million
The journal entry to record income taxes for 2006 would be:
Income Tax Expense $39.6 million
Income Tax Payable (current liability) $39.6 million
The 2006 net income can be calculated by subtracting the income tax expense from the pretax accounting income:
Net income = Pretax accounting income - Income tax expense
Net income = $89 million - $39.6 million
Net income = $49.4 million
Regarding the classification and reporting of deferred tax amounts on the 2006 balance sheet, we would need additional information about the nature of the deferred tax asset and deferred tax liability accounts to provide a detailed answer. Please provide further details regarding these accounts before I can assist you with their classification and reporting.
Lastly, it is possible for the cost of an asset to be less than the total depreciation, especially if there are factors such as salvage value or accelerated depreciation methods involved. In this case, the cost of the asset is $79 million, while the total depreciation over the years is $80 million. This could be due to factors such as bonus depreciation, which can result in a higher depreciation expense than the actual cost of the asset.
To determine the 2006 net income, we can start by considering the pretax accounting income of $89 million. We then need to adjust for the differences between pretax accounting income and taxable income.
1. Income from installment sales:
The excess of $3 million in income from installment sales included in pretax accounting income but not reported for tax purposes should be deducted. This reduces the pretax accounting income to $89 million - $3 million = $86 million.
2. EPA penalty:
The EPA penalty of $2 million should be deducted from the pretax accounting income. This further reduces the pretax accounting income to $86 million - $2 million = $84 million.
3. Difference in depreciation deductions:
We need to compare the income statement depreciation deductions with the tax return depreciation deductions and adjust accordingly.
In 2006, the difference is -$15 million, which means the income statement depreciation deductions were higher than the tax return deductions. We add this difference to the pretax accounting income, resulting in $84 million + (-$15 million) = $69 million.
4. Bad debt expense:
The bad debt expense reported for accounting purposes is $3 million, while for tax purposes, it is $2 million. The excess of $3 million - $2 million = $1 million should be added back to the pretax accounting income. This increases the income to $69 million + $1 million = $70 million.
5. Future absences expense:
The accrued expense for estimated paid future absences of $5 million should be deducted because it is not yet deductible on the tax return. This reduces the income to $70 million - $5 million = $65 million.
6. Loss contingency:
The estimated loss accrued in 2005 of $2 million is now tax deductible in 2006. This should be added back to the income. Therefore, the final net income for 2006 is $65 million + $2 million = $67 million.
Now let's address the classification and reporting of deferred tax amounts on the 2006 balance sheet.
Deferred tax amounts arise due to temporary differences between accounting income and taxable income, which may result in future tax liabilities or future tax assets.
In this case, we have a deferred tax asset of $1.2 million and a deferred tax liability of $2.8 million at the beginning of 2006. These amounts need to be classified and reported accordingly on the 2006 balance sheet.
Deferred tax assets represent future tax benefits resulting from deductible temporary differences or tax loss carryforwards. They should be classified as a noncurrent asset on the balance sheet.
Deferred tax liabilities represent the future tax impact of taxable temporary differences. They should be classified as a noncurrent liability on the balance sheet.
Therefore, on the 2006 balance sheet, the deferred tax asset of $1.2 million should be reported as a noncurrent asset, and the deferred tax liability of $2.8 million should be reported as a noncurrent liability.
Regarding your last question, it is indeed possible for the cost of an asset to be less than the total depreciation. In this case, the cost of the asset acquired in 2005 is $79 million, but the total depreciation over the years is summarized as $80 million. This typically occurs when there are adjustments to depreciation methods or changes in useful life assumptions. It may also happen if there are different depreciation methods applied for accounting and tax purposes. The resulting difference in depreciation deductions can lead to differences between the cost of the asset and the total depreciation amount.