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Chapter One
Introduction to Tax
In the context of accounting and finance, a tax is a mandatory financial charge or levy imposed
by a government on individuals, businesses, or other entities. Taxes are used to fund public
expenditures such as infrastructure, education, healthcare, and other government services. They
can take various forms, including income taxes, sales taxes, property taxes, and corporate taxes,
among others. Each type has its own set of rules and regulations governing how it is calculated
and collected.
Purpose of tax: The primary purpose of taxes is to generate revenue for the government to fund
public goods and services that benefit society. These include infrastructure (such as roads and
bridges), education, healthcare, national defense, public safety, and social welfare programs.
Taxes also help redistribute wealth, reduce inequalities, and influence economic behavior by
encouraging or discouraging certain activities through tax incentives or disincentives.
Additionally, taxes play a role in stabilizing the economy by providing the government with
tools to influence overall economic activity.
Characteristics and nature Tax: -
A. Compulsory Payment: Taxes are mandatory contributions imposed by the government.
Individuals and businesses are legally obligated to pay them, and non-compliance can result in
penalties or legal action.
B. No Direct Benefit: Unlike fees or charges, taxes do not provide a direct benefit or service to the
payer. Instead, they fund public goods and services that benefit society as a whole.
C. Legislative Authority: Taxes are imposed by legislative bodies, such as Congress or Parliament,
which establish the laws and regulations governing tax collection and administration.
D. Revenue Generation: The primary purpose of taxes is to raise revenue for government
operations and public services.
E. Economic Influence: Taxes can influence economic behavior by encouraging or discouraging
certain activities. For example, tax credits for renewable energy can promote environmental
sustainability.
F. Redistribution of Wealth: Through progressive tax systems, where higher earners pay a larger
percentage, taxes can help redistribute wealth and address income inequality.
G. Variety of Forms: Taxes come in various forms, such as income tax, sales tax, property tax, and
corporate tax, each with specific rules and rates.
1. Accounting for income Tax
Accounting for taxation in financial statements must begin with some consideration of the nature
of taxation. Although this might appear a simple question, taxation has certain characteristics
which set it apart from other business expenses and which might justify a different treatment, in
particular:
 Tax payments are not typically made in exchange for goods or services specific to the business
(as opposed to access to generally available national infrastructure assets and services); and
 The business has no say in whether or not the payments are to be made.
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1.1. Fundamentals of accounting for income taxes

Companies must file income tax returns following the guidelines developed by the appropriate
tax authority. Because IFRS and tax regulations differ in a number of ways, so frequently do
pretax financial income and taxable income. Consequently, the amount that a company reports as
tax expense will differ from the amount of taxes payable to the tax authority.
Pretax financial income is a financial reporting term. It also is often referred to as income
before taxes, income for financial reporting purposes, or income for book purposes. Companies
determine pretax financial income according to IFRS. They measure it with the objective of
providing useful information to investors and creditors.
Taxable income (income for tax purposes) is a tax accounting term. It indicates the amount used to
compute income taxes payable. Companies determine taxable income according to the tax regulations.
Income taxes provide money to support government operations.
1.2. The Tax base Concept
1.2.1. Tax base of assets: The tax base of an asset is the amount that will be deductible for tax purposes
against any taxable economic benefits that will flow to an entity when it recovers the carrying amount
of the asset. If those economic benefits will not be taxable, the tax base of the asset is equal to it
carrying amount.
In some cases, the ‘tax base’ of an asset is relatively obvious. In the case of a tax-deductible item of
PP&E, it is the tax-deductible amount of the asset at acquisition less tax depreciation already claimed.
Other items, however, require more careful analysis.
For example, an entity may have accrued interest receivable of €1,000 that will be taxed only on
receipt. When the asset is recovered, all the cash received is subject to tax. In other words, the
amount deductible for tax on recovery of the asset, and therefore its tax base, is nil. Another way
of arriving at the same conclusion might be to consider the amount at which the tax authority
would recognize the receivable in notional financial statements for the entity prepared under tax
law. At the end of the reporting period the receivable would not be recognized in such notional
financial statements, since the interest has not yet been recognized for tax purposes.
1.2.2. Tax base of liabilities
The tax base of a liability is its’ carrying amount, less any amount that will be deductible for tax
purposes in respect of that liability in future periods. In the case of revenue which is received in
advance, the tax base of the resulting liability is it carrying amount, less any amount of the
revenue that will not be taxable in future periods.
As in the case of assets, the tax base of some items is relatively obvious. For example, an entity
may have recognized a provision for environmental damage of 5 million, which will be
deductible for tax purposes only on payment. The liability has a tax base of nil. It carrying
amount is 5 million, which is also the amount that will be deductible for tax purposes on
settlement in future periods.
1.3. Differences between Financial and Taxable Profits
Income taxes payable can differ from income tax expense. This can happen when there are
temporary differences between the amounts reported for tax purposes and those reported for
book purposes. A temporary difference is the difference between the tax basis of an asset or
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liability and its reported (carrying or book) amount in the financial statements, which will result
in taxable amounts or deductible amounts in future years. Taxable amounts increase taxable
income in future years. Deductible amounts decrease taxable income in future years.
1.3.1. Temporary Difference
Temporary differences are differences between the carrying amount of an asset or liability in
the statement of financial position and its tax base. Temporary differences may be either:
A. Taxable temporary differences, which result in taxable amounts in determining taxable profit (tax loss) of
future periods when the carrying amount of the asset or liability is recovered or settled; or
B. Deductible temporary differences, which result in amounts that are deductible in determining taxable
profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered
or settled.
To illustrate how differences in IFRS and tax rules affect financial reporting and taxable income,
assume that Chelsea Inc. reported revenues of $130,000 and expenses of $60,000 in each of its
first three years of operations. The following is the financial reporting income of the company.

Tax reporting income

Income tax expense and income taxes payable differed over the three years but were equal in
total. The differences between income tax expense and income taxes payable in this example
arise for a simple reason. For financial reporting, companies use the full accrual method to
report revenues. For tax purposes, they generally use a modified cash basis. As a result, Chelsea
reports pretax financial income of $70,000 and income tax expense of $28,000 for each of the
three years. However, taxable income fluctuates. For example, in 2022 taxable income is only
$40,000, so Chelsea owes just $16,000 to the tax authority that year. Chelsea classifies the
income taxes payable as a current liability on the statement of financial position.
For Chelsea the $12,000 ($28,000 − $16,000) difference between income tax expense and
income taxes payable in 2022 reflects taxes that it will pay in future periods. This $12,000
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difference is often referred to as a deferred tax amount. In this case, it is a deferred tax liability.
In cases where taxes will be lower in the future, Chelsea records a deferred tax asset.
Future Taxable Amounts and Deferred Taxes
In Chelsea’s situation, the only difference between the book basis and tax basis of the assets and
liabilities relates to accounts receivable that arose from revenue recognized for book purposes.
Chelsea reports accounts receivable at $30,000 in the December 31, 2022, IFRS-basis statement
of financial position. However, the receivables have a zero-tax basis.
Assuming that Chelsea expects to collect $20,000 of the receivables in 2023 and $10,000 in
2024, this collection results in future taxable amounts of $20,000 in 2023 and $10,000 in 2024.
These future taxable amounts will cause taxable income to exceed pretax financial income in
both 2023 and 2024.
An assumption inherent in a company’s IFRS statement of financial position is that companies
recover and settle the assets and liabilities at their reported amounts (carrying amounts). This
assumption creates a requirement under accrual accounting to recognize currently the deferred
tax consequences of temporary differences. That is, companies recognize the amount of income
taxes that are payable (or refundable) when they recover and settle the reported amounts of the
assets and liabilities, respectively. Bellow shows the reversal of the temporary difference
described above and the resulting taxable amounts in future periods.

1.3.1.1. Deferred tax liability

It is the deferred tax consequences attributable to taxable temporary differences. In other words,
a deferred tax liability represents the increase in taxes payable in future years as a result of
taxable temporary differences existing at the end of the current year.
Recall from the Chelsea example that income taxes payable is $16,000 ($40,000 × .40) in 2022.
In addition, a temporary difference exists at year-end because Chelsea reports the revenue and
related accounts receivable differently for book and tax purposes. The book basis of accounts
receivable is $30,000, and the tax basis is zero. Thus, the total deferred tax liability at the end of
2022 is $12,000, computed bellow.
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Chelsea makes the following entry at the end of 2022.

Income tax expense 28,000

Income tax payable 16,000
Deferred tax liability 12,000
At the end of 2023 (the second year), the difference between the book basis and the tax basis of
the accounts receivable is $10,000. Chelsea multiplies this difference by the applicable tax rate to
arrive at the deferred tax liability of $4,000 ($10,000 × .40), which it reports at the end of 2023.
Income taxes payable for 2023 is $36,000 and the income tax expense for 2023 is as shown
below.

Deferred tax liability at end of 2023 $ 4,000

Deferred tax liability at beginning of 2023 12,000
Deferred tax expense (benefit) for 2023 (8,000)
Current tax expense for 2023 (income taxes payable) 36,000
Income tax expense (total) for 2023 $28,000
At the end of 2024 (the third and final year), the difference between the book basis and the tax
basis of the receivable is zero. Income taxes payable for 2024 is $32,000, and the income tax
expense for 2024 is $28,000 as shown below.

Deferred tax liability at end of 2024 $0

Deferred tax liability at beginning of 2024 (4,000)
Deferred tax expense (benefit) for 2024 (4,000)
Current tax expense for 2024 (income taxes payable) 32,000
Income tax expense (total) for 2024 $28,000
Chelsea records the income tax expense, the change in deferred tax liability, and income taxes
payable for 2024 as follows.

Income Tax Expense 28,000

Deferred Tax Liability 4,000
Income Taxes Payable 32,000
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The Deferred Tax Liability account at the end of 2024 is shown below and it has a balance of
zero:

Deferred tax liability

2023 8000 2022 12000
2024 4000

Financial statement effects

Chelsea reports the information on its statements of financial position for 2022–2024 as shown
below:

Income taxes payable is reported as a current liability, and the deferred tax liability is reported as
a non-current liability. On its income statement, Chelsea reports the information as shown below:

Companies also are required to show the components of income tax expense either in the income
statement or in the notes to the financial statements. For example, if Chelsea reported this
information in the income statement for 2022, the presentation is as shown below:

1.3.1.2. Deferred tax asset

A deferred tax asset is the deferred tax consequence attributable to deductible temporary
differences. In other words, a deferred tax asset represents the increase in taxes refundable (or
saved) in future years as a result of deductible temporary differences existing at the end of the
current year.
To illustrate, assume that Hunt Company has revenues of $900,000 for both 2022 and 2023. It
also has operating expenses of $400,000 for each of these years. In addition, Hunt accrues a loss
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and related liability of $50,000 for financial reporting purposes in 2022 because of pending
litigation. Hunt cannot deduct this amount for tax purposes until it pays the liability, expected in
2023. As a result, a deductible amount will occur in 2023 when Hunt settles the liability, causing
taxable income to be lower than pretax financial information. Below shows both the IFRS and
tax reporting over the two years.

In this case, Hunt records a deferred tax asset of $20,000 at the end of 2022 because it represents
taxes that will be saved in future periods as a result of a deductible temporary difference existing
at the end of 2022. Below shows the computation of the deferred tax asset at the end of 2022
(assuming a 40 percent tax rate).

Hunt can also compute the deferred tax asset by preparing a schedule that indicates the future
deductible amounts due to deductible temporary differences. Below shows this schedule.
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Assuming that 2022 is Hunt’s first year of operations and that income taxes payable is $200,000,
Hunt computes its income tax expense as shown below.

The deferred tax benefit results from the increase in the deferred tax asset from the beginning to
the end of the accounting period (similar to the Chelsea example earlier). The deferred tax
benefit is a negative component of income tax expense. The total income tax expense of
$180,000 on the income statement for 2022 thus consists of two elements—current tax expense
of $200,000 and a deferred tax benefit of $20,000. Hunt makes the following journal entry at the
end of 2022 to record income tax expense, deferred income taxes, and income taxes payable.

Income Tax Expense 180,000

Deferred Tax Asset 20,000
Income Taxes Payable 200,000

At the end of 2023 (the second year), the difference between the book value and the tax basis of
the litigation liability is zero. Therefore, there is no deferred tax asset at this date. Assuming that
income taxes payable for 2023 is $180,000, Hunt computes income tax expense for 2023 as
shown below.

Income Tax Expense 200,000

Deferred Tax Asset 20,000
Income Taxes Payable 180,000
Financial Statement Effects
Hunt Company reports the following information on its statements of financial position for 2022
and 2023 as shown below.
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Income taxes payable is reported as a current liability, and the deferred tax asset is reported as a
non-current asset. On its income statement, Hunt Company reports the information as shown
below.

As illustrated, Hunt reports both the current portion (the amount of income taxes payable for the
period) and the deferred portion of the income tax expense. In this case, the deferred amount is
subtracted from the current portion to arrive at the proper income tax expense. Below shows the
Deferred Tax Asset account at the end of 2023.

Deferred Tax Asset

2022 20,000 2023 20,000

Exercise: In 2017, Almirante Corporation had pretax financial income of $168,000 and
taxable income of
$120,000. The difference is due to the use of different depreciation methods for tax and
accounting purposes. The effective tax rate is 40%.

Compute the amount to be reported as income taxes payable at December 31, 2017. Pass the
Journal Entry

1.3.2. Permanent Differences

Permanent differences result from items that (1) enter into pretax financial income but never into
taxable income, and vice versa. Congress has enacted a variety of tax law provisions to attain
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certain political, economic, and social objectives. Some of these provisions exclude certain
revenues from taxation, limit the deductibility of certain expenses, and permit the deduction of
certain other expenses in excess of costs incurred.

Since permanent differences affect only the period in which they occur, they do not give rise to
future taxable or deductible amounts. As a result, companies recognize no deferred tax
consequences.

Items recognized for financial reporting purposes but not for tax purposes.
 Interest received on state and municipal obligations.
 Expenses incurred in obtaining tax-exempt income.
 Proceeds from (Premiums paid for) life insurance carried by the company on key officers or
employees.
 Fines and expenses resulting from a violation of law.

Items recognized for tax purposes but not for financial reporting purposes.
 “Percentage depletion” of natural resources in excess of their cost.
 The deduction for dividends received from Gov’t corporations.
To illustrate this, assume that Bio-Tech Company reports pretax financial income of $200,000 in
each of the years 2015,16, and 17. The company is subject to a 30% tax rate and has the
following differences between pretax financial income and taxable income. It pays life insurance
premiums for its key officers of $5,000 in 2016 and 2017. Although not tax-deductible, Bio-Tech
expenses the premiums for book purposes.

Bio-Tech reports gross profit of $18,000 from an installment sale in 2015 for tax purposes over an 18-
month period at a constant amount per month beginning January 1, 2016. It recognizes the entire amount
for book purposes in 2015. The installment sale is a temporary difference, whereas the life insurance
premium is a permanent difference.

Bio-Tech deducts the installment-sales gross profit from pretax financial income to arrive at
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taxable income Because Pretax financial income includes the installment-sales gross profit;
taxable income does not.
Conversely, it adds the $5,000 insurance premium to pretax financial income to arrive at taxable
income Because Pretax financial income records an expense for this premium, but not for tax
purposes. Therefore, the life insurance premium must be added back to pretax financial income
to reconcile to taxable income.

Bio-Tech has one temporary difference, which originates in 2015 and reverses in 2016 and 2017.
As the temporary difference reverses, Bio-Tech reduces the deferred tax liability. There is no
deferred tax amount associated with the difference caused by the nondeductible insurance
expense because it is a permanent difference.
Although an enacted tax rate of 30% applies for all three years, the effective rate differs from the
enacted rate in 2016 and 2017. Bio-Tech computes the effective tax rate by dividing total
income tax expense for the period by pretax financial income. The effective rate is 30% for 2015
($60,000 ÷ $200,000 = 30%) and 30.75% for 2016 and 2017 ($61,500 ÷ $200,000).
1.4. Revision of Future Tax Rates
When a change in the tax rate is enacted, companies should record its effect on the existing
deferred income tax accounts immediately. A company reports the effect as an adjustment to
income tax expense in the period of the change.
Assume that on December 10, 2017, a new income tax act is signed into law that lowers the
corporate tax rate from 40%to 35%, effective January 1, 2019. If Hostel Co. has one temporary
difference at the beginning of 2017 related to $3 million of excess tax depreciation, then it has a
Deferred Tax Liability account with a balance of $1,200,000 ($3,000,000 × 40%) at January 1,
2017. If taxable amounts related to this difference are scheduled to occur equally in 2018, 2019,
and 2020, the deferred tax liability at the end of 2017 is $1,100,000, computed as follows.
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Hostel, therefore, recognizes the decrease of $100,000 ($1,200,000 – $1,100,000) at the end of
2017 in the deferred tax liability as follows.

Deferred Tax Liability--------------100,000

Income Tax Expense--------------100,000

Corporate tax rates do not change often. Therefore, companies usually employ the current rate.
However, state and foreign tax rates change more frequently, and they require adjustments in
deferred income taxes accordingly.

1.5. Accounting for net operating losses

Every management hopes its company will be profitable. But hopes and profits may not
materialize. For a start-up company, it is common to accumulate operating losses while it
expands its customer base but before it realizes economies of scale. For an established company,
major events such as a labor strike, rapidly changing regulatory and competitive forces, a
tsunami, or a general economic recession such as that experienced in the wake of the COVID-19
pandemic can cause expenses to exceed revenues—a net operating loss.
A net operating loss (NOL) occurs for tax purposes in a year when tax deductible expenses
exceed taxable revenues. An inequitable tax burden would result if companies were taxed during
profitable periods without receiving any tax relief during periods of net operating losses. Under
certain circumstances, therefore, tax laws permit taxpayers to use the losses of one year to offset
the profits of other years.
Companies accomplish this income-averaging provision through the carryforward of net
operating losses. Under this provision, a company pays no income taxes for a year in which it
incurs a net operating loss. In addition, it can reduce future taxes payable as discussed below.
1.5.1. Loss carryforward
Through the use of a loss carryforward, a company may carry the net operating loss forward to
offset future taxable income and reduce taxes payable in future years. Operating losses can be
substantial. For example, VW Group (DEU) had €2.5 billion in tax loss carryforwards at the end
of 2018. At VW’s effective tax rate, that would imply over €500 million in reduced taxes if it is
able to generate taxable income.
Because companies use carryforwards to offset future taxable income, the tax effect of a loss
carryforward represents future tax savings. However, realization of the future tax benefit depends
on future earnings, an uncertain prospect.
The key accounting issue is whether there should be different requirements for recognition of a
deferred tax asset for (a) deductible temporary differences, and (b) operating loss carryforwards.
The IASB’s position is that in substance these items are the same both are tax deductible
amounts in future years. As a result, the Board concluded that there should not be different
requirements for recognition of a deferred tax asset from deductible temporary differences and
operating loss carryforwards.
1.5.2. Carryforward (Recognition)
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To illustrate the accounting procedures for a net operating loss carryforward, assume that Groh
Inc. has no temporary or permanent differences. Groh experiences a net operating loss of
$200,000 in 2022 and takes advantage of the carryforward provision. In 2022, the company
records the tax effect of the $200,000 loss carryforward as a deferred tax asset of $40,000
($200,000 × .20), assuming that the enacted future tax rate is 20 percent. Groh records the benefit
of the carryforward in 2022 as follows.

Deferred Tax Asset 40,000

Income Tax Expense (Loss Carryforward) 40,000
Groh establishes a Deferred Tax Asset account for the benefits of future tax savings. The account
credited [Income Tax Expense (Loss Carryforward)] is a contra income tax expense item, which
Groh presents on the 2022 income statement shown below. The $40,000 is the deferred tax
benefit for 2022, which results from an increase in the deferred tax asset.

For 2023, assume that Groh returns to profitable operations and has taxable income of $250,000
(prior to adjustment for the NOL carryforward), subject to a 20 percent tax rate. Groh then
realizes the benefits of the carryforward for tax purposes in 2023, which it recognized for
accounting purposes in 2022. Groh computes the income taxes payable for 2023 as shown below.

Groh records income taxes in 2023 as follows.

Income tax expense 50,000

Deferred tax asset 40,000
Income taxes payable 10,000
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The benefits of the NOL carryforward, realized in 2023, reduce the Deferred Tax Asset account
to zero.
Groh Inc.
Income Statement (partial) for 2023

Income before income taxes $250,000

Income tax expense:
Current $10,000
Deferred 40,000 50,000
Net income $200,000

1.5.3. Carryforward (non-recognition)

Let us return to the Groh example, assume that it is more likely than not that Groh will not
realize the entire NOL carryforward in future years. In this situation, Groh does not recognize a
deferred tax asset for the loss carryforward because it is probable that it will not realize the
carryforward. As a result, there is no journal entry in 2022 for income taxes by Groh. Below
shows Groh’s 2022 income statement presentation.
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In 2023, assuming that Groh has taxable income of $250,000 (before considering the
carryforward) subject to a tax rate of 20 percent, it realizes the deferred tax asset. Groh records
the following entries.

Groh reports the $40,000 Income Tax Expense (Loss Carryforward) on the 2023 income
statement. The company did not recognize it in 2022 because it was probable that it would not be
realized. Assuming that Groh derives the income for 2023 from continuing operations, it
prepares the income statement as shown below.

Non-Recognition Revisited
Whether the company will realize a deferred tax asset depends on whether sufficient taxable
income exists or will exist within the carryforward period available under tax law. Below shows
possible sources of taxable income and related factors that companies can consider in assessing
the probability that taxable income will be available against which the unused tax losses or
unused tax credits can be utilized.
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To the extent that it is not probable that taxable profit will be available against which the unused
tax losses or unused tax credits can be utilized, the deferred tax asset is not recognized. Forming
a conclusion that recognition of a loss carryforward is probable is difficult when there is negative
evidence (such as cumulative losses in recent years). However, companies often cite positive
evidence indicating that recognition of the carryforward is warranted.
Unfortunately, the subjective nature of determining impairment for a deferred tax asset provides
a company with an opportunity to manage its earnings. As one accounting expert notes, “The
‘probable’ provision is perhaps the most judgmental clause in accounting.” Some companies
may recognize the loss carryforward immediately and then use it to increase income as needed.
Others may take the income immediately to increase capital or to offset large negative charges to
income.
1.6. Financial statement presentation Statement of Financial Position
Companies classify taxes receivable or payable as current assets or current liabilities. Although
current tax assets and liabilities are separately recognized and measured, they are often offset in
the statement of financial position. The offset occurs because companies normally have a legally
enforceable right to set off a current tax asset (Income Taxes Receivable) against a current tax
liability (Income Taxes Payable) when they relate to income taxes levied by the same taxation
authority.
Deferred tax assets and deferred tax liabilities are also separately recognized and measured but
may be offset in the statement of financial position. The net deferred tax asset or net deferred tax
liability is reported in the non-current section of the statement of financial position.
To illustrate, assume that K. Scott Company has four deferred tax items at December 31, 2022,
as shown below.

Temporary Difference Resulting Deferred Tax

(Asset) Liability
1. Rent collected in advance: recognized when performance
obligation satisfied for accounting purposes and when received for tax $(42,000)
purposes
2. Use of straight-line depreciation for accounting purposes and
accelerated depreciation for tax purposes.
$214,000
3. Recognition of profits on installment sales during period of sale for
accounting purposes and during period of collection for tax
45,000
purposes.

4. Warranty liabilities: recognized for accounting purposes at time

of sale; for tax purposes at time paid.
(12,000)
Totals $(54,000) $259,000
As indicated, K. Scott has a total deferred tax asset of $54,000 and a total deferred tax liability of
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$259,000. Assuming these two items can be offset, K. Scott reports a deferred tax liability of
$205,000 ($259,000 − $54,000) in the non-current liability section of its statement of financial
position.
Income Statement
Companies allocate income tax expense (or benefit) to continuing operations, discontinued
operations, other comprehensive income, and prior period adjustments. This approach is referred
to as intra-period tax allocation. In addition, the components of income tax expense (benefit)
may include:
1. Current tax expense (benefit).
2. Any adjustments recognized in the period for current tax of prior periods.
3. The amount of deferred tax expense (benefit) relating to the origination and reversal
of temporary differences.
4. The amount of deferred tax expense (benefit) relating to changes in tax rates or the
imposition of new taxes.
5. The amount of the benefit arising from a previously unrecognized tax loss, tax credit,
or temporary difference of a prior period that is used to reduce current and deferred tax expense.

Comprehensive exercise

Allman Company, which began operations at the beginning of 2016, produces various products
on a contract basis. Each contract generates a gross profit of $80,000. Some of contracts provide
for the customer on an installment basis. Under these contracts, Allman collects one-fifth (20%)
of the contract revenue in each of the following four years. For financial reporting purposes, the
company uses accrual basis and for tax purposes, Allman uses installment basis (cash basis ).
Information related to Allman’s operations for 2016 are given below.

In 2016, the company completed seven (7) contracts that allow for the customer to pay on an
installment basis. Allman recognized the related gross profit of $560,000 (7 x 80,000) for
financial reporting purposes. It reported only $112,000 (20% x 560,000) of gross profit on
installment sales on the 2016 tax return. The company expects future collections on the related
installment receivables to result in taxable amounts of $112,000 in each of the next four years.
At the beginning of 2016, Allman Company purchased depreciable assets with a cost of
$540,000. For book purposes, Asset depreciates using the SLM over 6 yrs. For tax purposes, the
assets fall in the five-year recovery class, and Allman uses the MACRS system.
Depreciation computation

Year Depreciation for Book Depreciation for Tax Purposes Difference

Purposes
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2016 $ 90,000 $108,000 $(18,000)

2017 90,000 172,800 (82,800)
2018 90,000 103,680 (13,680)
2019 90,000 62,208 27,792
2020 90,000 62,208 27,792
2021 90,000 31,104 58,896

$540,000 $540,000 $ –0–

1. During 2016, the product warranty liability accrued for book purposes was $200,000, and the
actual paid for warranty liability was $44,000. Allman expects to settle the remaining
$156,000 by expenditures of $56,000 in 2017 and $100,000 in 2018.
2. In 2016, nontaxable municipal bond interest revenue was $28,000.
3. In 2016, nondeductible fines and penalties of $26,000 were paid.
4. Pretax financial income for 2016 amounts to $412,000.
5. Tax rates enacted up to 2016 were 50% and for 2017 and later years 40%.
Required
I. Identify temporary and permanent differences?
II. Determine taxable income of 2016?
III. Computes income taxes payable for 2016?
IV. Compute future taxable amount (DTL) at the end of 2016?
V. Compute future deductible amount (DTA) at the end of 2016?
VI. Compute net deferred tax expense (DTL - DTA) for 2016?
VII. Compute total income tax expense (deferred + current) of 2016?
VIII. Records income taxes payable, deferred income taxes, and income tax expense of 2016?
IX. Show the financial presentation.