problem set 6

1. No book or tax differences. Otis Optics, Inc. began business in 2022. The company
billed and collected $500,000 in revenue. Assume that Otis did not incur any expenses
during the year. Important: we are assuming that this sales transaction is treated
identically for both book and income tax purposes. The tax rate is 35%, and Otis will
pay any income taxes due in 2023.
What journal entries are required to record income tax expense/payable in 2022?

↳ income tax expense =

income tax
payable
book income =
taxable income

to record income tax expense :

500,000 * 35% =
$175,000

Dr Income Tax Expense $175,000

$175,000
.

or . Income tax
payable

2. Permanent Book-Tax Differences. Modifying the previous example, assume that Otis Optics, a U.S.
GAAP reporter, began business in 2022 and collected $500,000 in revenue. In addition to its 2022 sales
revenue, Otis Optics received $40,000 of municipal bond interest revenue, which is included in book
income on the income statement but is not taxable. Otis Optics did not incur any expenses during the
year. The company is subject to a 35% income tax rate.
What journal entries are required to record income tax expense/payable for the year? What is the
company’s effective tax rate?

Income tax expense :

income
before taxes $540,000
calculation less : permanent differences ($40,0007
Adjusted $500,000

}?:o)
pretax Income
Tax Rate Permanent does
Income tax expense $175,000 not
change tax
rate to
differ but
Income tax
Payable : Taxable Income , does
change ETR
Tax Rates from rate
Income
351 .

statutory tax
tax
payable $175,000
Effective Tax Rate =
Income Tax Expense
=
$175,000 = 32141
$540,000
.

Pretax Income
7300K

Dr . Income Tax Expense $175,000

Dr
. Income Tax
Payable $175,000
3. DTL. Otis Optics, Inc. began business during 2022 and collected $500,000 in sales revenue. Otis Optics
also sold $60,000 of merchandise as installment sales (i.e., the customer will pay in installments over time).
None of the installment sales is collected during the current year. Ignore cost of goods sold and assume that
the company did not incur any expenses during the year. In addition, Otis did not report any permanent
I

→ still recognize revenue for

book this
differences. The company’s tax rate is 35%. year
Important: Installment sales are considered revenue (and installment sales receivable) for book (i.e., for →
- for tax whencollected
recognized $$
GAAP) purposes, but not for tax (e.g., IRS) purposes. Otis will only recognize revenue on installment sales
for tax purposes when it collects cash.
What journal entries are required for the year to record the income tax-related entries? How do YOU know its a DK ?
* installment sales receivable → book > tax ①conceptually
* scenario 2→ Deferred tax liability ↳ have a tax liability
ble push off tax until cash
DTL =
1Asset Book Basis -

) *
Asset Tax Basis
statutory tax rate is collected
$60,000
} temporary difference
Asset Book Basis = ↳ have a transaction we didnot
Asset tax basis =
$0 → don't recognize taxes on
receivable pay
DTL =($60,000 -

$0) # 35% OR
=
$21,000 ② Book Basis v5 .
Tax Basis

and if its an asset

/liability
Income Tax Expense Income
Payable
Tax

Income
Before Taxes =
Taxable Income $500,000
= ③ Preparing journal entry
$500,000 $60,000 *NI Installment sales revenue →
difference between
-

=
$560,00041Tailment -

"'" R"
Income tax payable =
$500,000 -1×351 .
income tax expense e income
Income tax exp :
=
$175,01 tax payable is
DTAIDTL
=
.gg#atO
$560,000 * 351
$196,000,2
less tax
paid today , so
more will be paid later → DTL
dr
L
.
& .

Journal Entries DTL

$509000 originates 22

¥1,000
Dr . cash ←

Cr .
sales revenue $500,000

Dr Installment sales
.
receivable $60,000
Cr Installment sales revenue
.
$60,000 * DTL represents the future
taxes we will pay on income
Dr.
Income tax
expense $196,000 taxes payable@ a result of
cr .
Income Tax
Payable $175,000 actions that have already occurred
but can't yet tax)
cr .
Deferred Tax Liability $21,000
 4. DTL Reversal. Continuing with previous example, assume that Otis Optics collected
when it reverses
.cl#nseDTA
•

the $60,000 of installment sales receivable in 2023. This amount is now taxable income
because it is collected in cash. Otis already recorded book income for installment sales
in 2022, along with the related installment sales receivable, so there is no book income
•
must look at /understand prior info
recognized in the year of cash collection. In addition, Otis collected cash of $200,000
for regular sales during 2023, which is treated the same for book and tax purposes.
ohhh
Ignore cost of goods sold and assume no operating expenses in 2023.
* don't WAYS teterseitingndgog
What is the journal entry to record income taxes for the year? may be in
yr . 3. Me .

Income
Income tax expense Tax
Payable
Sales Revenue $200,000 SR $200,000 taxable income
Installment jgmowble collected in$$
attecboegennized
→
Installment SR $0 sa $60,000
Income by tax $200,000 Taxable Income $260,000
Tax Rate 35% TAX Rate 35%
ITP $91,000
Income tax Exp $70,000

¥=$É
Dr . Cash $200,000
or .
Sales Revenue $200,000 DTL
000 → originates in
reversal in
Dr .
Cash $60,000 2023921,000
2022

or .
Installment sales receivable $60,000 0

Dr Income
. tax expense $70,000 * good to nset account
-

☐r .
Deferred tax
liability $21,000 especially when reversal
Cr . Income Tax
Payable $91,000 spans a couple of genre
habitabilityof DTA
5. DTA. Otis Optics reported sales and collected cash of $500,000 in 2022 and no permanent
differences. The company also recorded an estimated product warranty liability and the
related warranty expense of $110,000 for book purposes. Ignore cost of goods sold and
assume there were no additional expenses in 2022. Under the tax law, Otis← cannot deduct the
estimated warranty expense and does not create a tax liability for these amounts until it → cannot tax
actually provides the services by repairing the product. The company’s tax rate is 35%.
What journal entries are required for the year to record the income tax-related accounts? until services provided
21300K Basis > Basis Tax
so it is a PTA
b/c
warranty expense has
DTA -_
(BOOK Basis -

Tax Basis ) * statutory tax rate

not been deducted from
=
5/110,000*35%1 the taxable income in the
•
firstyear ,
=
$38,500 • •
making taxable income
GREATER than income blflaxes
Income Tax Expense Income Tax
Payable → make taxes
greater now ,
sales Rev $500,000 sales Rev $500,000 so less in the
future
,
1110,000 ) $0
warranty expense warranty exp it is
Income B4 taxes 390,000 taxable Income $500,000
Tax Rate 35% TAX Rate 351.

Income tax Expense $136,500 $175,000 Originates in 2021

Journal Entries
☐a=¥%É { $38,500
DtA_

Dr .
Income Tax Expense $136,500
Dr .
Deferred Tax Asset $38,500
Cr Income tax
.

payable $175,000
 6. DTA Reversal. Continuing with the previous example, assume that Otis Optics made
actual warranty repairs at a total cost of $110,000 in 2023. The company also reported
and collected cash for $300,000 in sales revenue and did not incur any additional
expenses for the year. Ignore cost of goods sold. The company is subject to a 35%
income tax rate and does not report any permanent differences.
What journal entries are required to record this year’s income tax provision?

Income Tax Expense Income Tax

Payable Ñe☒,
€1300,000 * 351 . f-$300,000 -910,0007*351 .

G④☒
=
$105,000 =
$664500-6dam warranty -

expense since warranty repairs performed

Deferred Tax Asset

warranty Liability
\
Beg $38,500
. Dr.
$110,000
change $381500 Cr.
Cash $110,000
End 0

Dr .
Income Tax Expense $105,000
Cr . Income tax payable $66,500
Cr .
Deferred Tax Asset $38,500
7. DTA Realizability. Consider Otis Optics from the previous example. The company recorded
$500,000 in sales revenue in 2022. Ignore cost of goods sold. The company is subject to a 35%
tax rate. Otis recorded a deferred tax asset of $38,500 in 2022 due to a $110,000 basis difference
- -
DTA → expect benefit /lower taxes) infntnre
but don't hate taxable income
in warranty liabilities ($110,000 × 35%). Based on its assessment of all positive and negative
- if we
evidence associated with this deferred tax asset, management has assessed that it is more likely in the don'tgain that
than not that it will not realize 40% of the deferred tax asset. future we
benefit
↳
,

not have
What are the necessary journal entries to record the deferred tax asset and valuation EX :
start-ups might
allowance?
scenario 4 (book basis > tax basis a ) { liability taxable income until later
contra -

asset
Income Tax Expense :($500,000 -81790003*351
}
.

DTA
$136,500 =
valuation Allowance
ITP =
$500,000 * 35% $175,000 =
$15,400
DTA __
$38,500 qenew value of DEA
NRV :
$38,500 # 60% =$23, DEA -1175,000-1136/500115,4007]
Valuation Allowance -_
$38,50014401 .
=
$15,400 =
23,700

Journal Entries
Dr Income tax
. expense $136,500
Dr .
Deferred tax Asset $38,500
Cr. Income Tax
Payable $175000

Dr Income.
tax expense $15,400 → increases income tax expense
or . valuation Allowance for DEA $15,400 to $151,900
(contra asset that reduces DTA value)
-

→ And ETR
 * similar idea to compensated
8. Future Income Taxes. Lands Canoes recorded book income of $100,000 in 2022. The absences
company did not have any permanent differences; the company’s only temporary

nsefntnreknowntaxratesfortbe-c-ren-tpen.ae
difference relates to a $30,000 warranty expense that it recorded on the income *
statement but cannot deduct for tax purposes until actual repairs are made. Lands
Canoes anticipates satisfying the warranty liability equally over the next three years.
The current enacted tax rate is 40%. The enacted tax rates for 2023, 2024, and 2025 are
35%, 30%, and 30%, respectively.
Determine the value of the deferred tax asset to be recorded for this temporary book-
tax difference.

scenario ↳ →
warranty Liability
*
Deferred Tax Asset
Matronly included in book
income
of $100,000
$30,000 warranty liability reversed corer 3
years
↳ $10,000/yr
reversed each
DTA year
{ 2023 2024 2025 Total

Difference $10,000 $10,000 $10,000 $30,000

Relevant ITR * 35% * 30% * 30%

DTA $3,500 $3,000 $3,000 $9,500

ITE ITP
prewarmnty
Income
Exp
$130,000 Pre-tax Income $130,000
($30,000) warranty exp ($07
warranty exp
Pretax Book Income $100,000 Taxable Income $130,000
Tax Rate 4 Tax Rate 40%
40 wro→ $52,000 → income tax
payable always based
don't care about
lgmnstadjnstthisblcoffntnretaxrate on current tax rate →
future rates
→ DTA
refers to impact on
future
tax rate
→ Remember : ITE based on accrualbasis
correct Journal entry :
$42,500
] origination year
Dr . Income Tax Expense
☐r .
Deferred Tax Asset $9,500
Cr .
Income Tax
Payable $gy, ,, ,

Next Year/2023)
☒

pre-warmntyexp.sk#oo$-2o,o-oocr.DtACr.ITp
Dr. 7- TE É
$3,500 →
$-3,5009 Nanolnty EXP c.10,000]
-

Pre-tax Booktntome $20,000 $10,000

*these #s made
*$}%→
* 351 .

up
$7,000
DTA
20229,500
3,500 2023
?⃝
9. Future Income Taxes. Whitewater Rafts, Inc. had reported a net deferred tax asset of
$137,000 resulting from an estimated warranty expense accrual for book purposes and
using a 35% statutory tax rate. The total book-tax difference related to the bases of the
estimated warranty liability is $391,429. The enacted statutory tax rate related to this
balance changed from 35% to 30%, effective immediately.
What journal entry will Whitewater Rafts need to make to adjust for this change in tax

rgtemporary difference
rates?
DTA
warranty exp/ liability :$ -94-429*351
137,000J
.

original ←

initial DTA -_
$137,000 19,571
→ tax rate change 117,429
adjusted DTA $391,429 * $117,429
-
-

* when tax rated, DTA

tax rates decreased
Dead b/c ,so the future
}ifDTAt taxexpenset
then
, loses its value and not as
tax deductions taken are less valuable income
beneficial anymore
ETRT

adjustment to DTA -_
$137,000 $117,429 $19,571
- -_

Journal Entry * DON'T use

$19,571 djnst
] for
Dr . Income Tax Expense to PTA valuation allowance
cr.be/emedTaxAsset $19,57,
change in tax rate tax rate
is
→
change
concrete, while
* use future tax rates
if known # valuation might/minks
happen

10. NOL Carryback. Lawson Enterprises experienced an NOL of $567,000 TAX Loss : Taxable < Tax expense
in 2022. Lawson operates in a jurisdiction that allows NOLs to be carried Income

back two years. The company reported taxable income of $434,000 in 2020
and $327,000 in 2021. The tax rate for all years is 40%. Lawson elects to
carryback the NOL.
What is the necessary journal entry to record the NOL carryback in the year
of the loss? NOL total
20-20 202-1 202-2
carryback
Taxable Income (loss) $434,000 $327,000 (567,000 )

carryback
carried backfirst [$434,000) [ $133,000) (567-1000)
102020 and then
d
remaining to 2022
434,000-5671000

20-20 202-1 Total Lawson will have $194,000

($434,000) $133,000) ($560,0007
carryback (0.6 taxable income
.

of $327,000
40% less $133,000 Used )
Tax rate 40% 401.

remaining
TAX Benefit ($173,600) $53,200 ($226,800] from 2021 that could be used
↳ what the company cnnolaim to offset an Nolin 2023
a refundfor /becausefirm can back
carry
Journal Entry up to 2
yrs)
Dr. Income Tax Refund Receivable $226,800 A Asset)
Cr
. Income Tax
Benefit $226,800 IT equity via TNI )
↳ opposite of income tax expense, which reduces equity
* on income statement appears as

Net loss b4 tax benefit ($567,000)

Income Tax Benefit 226,800
Net loss
after tax benefit $1340,200)
 11. NOL Carryforward: Year of NOL. Piewares, Inc. began business in
2022 and reported sales revenue of $500,000 and expenses of $600,000,
resulting in a $100,000 net loss for the current year. Assume that Piewares
has no permanent or temporary differences; thus, its taxable loss equals its
book loss of $100,000. Because it began business in 2022, the carryback
option is not available, so Piewares must carry forward its $100,000 NOL.
The tax rate is 35% and a valuation allowance is not required.
What is the necessary journal entry to record the impact of the NOL
carryforward on the company’s financial statements?

NOL carryforward
__
($100,000)
Income Tax Benefit __
$100,000 * 351 .

=
$35,000
↳ DTA is the same value

taxes
* company does any income
not record
owe
any taxes

payable for the current

year

Dr .

Deferred Tax Asset $35,000 → use DTA instead

of refund receivable ,
b/c
or . Income Tax Benefit $35,000 nsedinthefntnre.no/-acnhont
tax benefit )
* when acompany carriesforward an NOL it realizes DTA benefits carrybokkoscnrronttaxbenefit
camyfonrardosfntnrltax benefit
,
in
future periods when taxable income is earned

12. NOL Carryforward: Years following the NOL. In the ITE 7- TP

prior example, we determined that Piewares has a deferred
tax asset of $35,000 related to the $100,000 NOL in 2022. In Rev 500,000 $500,000
2023, the company generates revenues of $500,000 and incurs
operating expenses of $200,000. Again, there are no Exp 1200,000 ) 1200,000)
temporary or permanent differences, meaning book income NOLCF (10%000) 2
is equal to taxable income. So, Piewares reports taxable
income of $300,000 before considering the effect of its NOL.
Ptetax BI 305,000 Taxable
Income 209000 NOL
forward
The company’s statutory tax rate is 35%. * 35% * 351 .
carry
in Iep to
What is the tax-related journal entry for 2023? -105,000 70,00T reduce taxable
income
70191 NOL
2022 zozz
carryforward
taxable Income floss) ($100,0001 $300,000 -

carryforward carryforwardN0Lt02019 $1100,000) ($100,000)

:

Taxable Income
after carryforward $200,000

Income Tax
Payable =
$200,000 * 35%
-
'

$70,000 PTA
35,000
Income tax benefit realized -_
$1100,000) -1×351=(5/35,000) 35,000
↳ removed from 0

TEH DIA account

Dr Income
.
Tax Expense $105,000
er .
Deferred Tax Asset
$35,000 → fully realizes NOL
carryforward benefits
Cr .
Income Tax
payable $70,000
No Piewares still has $200,000 of taxable incomefrom 2023 that can be used to
offset dfntnre NOL
occurring
in 2024 2025 ( )
Noluptotwo years
assuming afirmcancarrybackan
or
13. NOL Carryforward Realizability. Consider the Piewares example. In
2022, the company experienced a $100,000 net operating loss and recorded a
deferred tax asset of $35,000. Now assume that Piewares decides that it is
more likely than not that it will only be able to generate $60,000 of taxable
income during the carryforward period. As a result, without generating an
additional $40,000 of future taxable income it will not be able to fully realize
the NOL carryforward benefit.
What journal entries necessary to record the net deferred tax asset in 2022?

→ must
recognize a valuation allowance ggtaxableincome
rqtgegaobpeeminjgyose-M-47.int ) OR $60,000 * 351 .
=
$21,000
$60,0002 = 60% of DTA is realized $40,000 * 35% =

$14,000
$100,000 Gadditional
future taxable
income
$35,000 * 60% =
$21,000 realized
unrealized
what goes into
=
$14,000 →
valuation allowance account

Tax Benefit recorded in

202€ :
Dr .

Deferred
cr Income
.
Tax Asset
Tax
Benefit
$35,000
$3s ,
ooo
] just recording the DTA

netrealizability
of the DTA on Bls
Decrease in Tax Benefit : DTA t
DTA
valuation Allowance
b
Dr . Income Tax Benefit $14,000 $35,000 $14,000
Cr . valuation Allowance for DTA $14,000 = $211000
↳ $35,000 # 601 .

↳ 100,00011004
¥÷÷
* 351 .
14. NOL Carryback and Carryforward. Backus Inc. reported a loss
of $500,000 in 2022. The company reported taxable income of
$125,000 in 2020 and $230,000 in 2021. It has no permanent or
temporary differences and its tax rate is 35%.
What is the necessary journal entry for 2022? Backus reported
taxable income of $250,000 in 2023. What is the necessary journal
entry for 2023?
2020 2021 2022
Taxable Income $125,000 $230,000 $500,000)
carrybacklloss) $124009
( ($230,000)
qsqqgo.gg#ftocemyfonvendto2023
. . .

carryforward forward → carry

carry back $125,000 $230,000 $355,000 i. $145,000
¥¥so¥É $12452T ;$%¥¥→
Tax rate '

Income tax benefit

Tax
benefit of Nolcarnyback $124,250
TAX
Benefit ofiwlcanyfomard 50,750
$175,000

Income tax
refund Receivable $124,250
Deferred Tax Asset
$50,750
Income tax Benefit $175,000
HeantonIt
taxable thumb
Income tax Benefit
$250,000
1145,000 )
[n income $250,000 ¥277,000
-
1145,0007
AdjtaxabkRate Income $105,000 pretax BI
:
$250,000 ¥¥Tome¥000
Tax of 351 .
* 351. * 351.

ITP $36,750 $36,750

Ite :
$87,500 Itp :

Dr Income tax
.
expense
Asset
$87,500
Cr .
Deferred eat
$50,750
Income eax
Cr .

Payable $36,750