Chapter 15 - Additional Case Key Points
This question requires students to identify and calculate temporary differences for income tax purposes and to determine the impact these differences will have on a companys financial statements. Included in the scenario is the sale of capital assets on which there are nontaxable permanent differences.
Sale of Land and Building: Computations
|Gain on Sale||$2,500,000|
|Half of gain ($2,500,000 x 50%)||$1,250,000|
|Gain on Sale||$2,800,000|
|Half of gain (Proceeds less cost)|
|($5,000,000 - $4,000,000) x 50%||$500,000|
|Accounting gain included in income:|
|Taxable Capital Gain|
|Recapture on sale of building: The lesser of proceeds and cost, less UCC.|
|Recapture is fully taxable.|
The income statement will record a gain on the sale of capital assets of $5,300,000. This gain should be deducted from the income. The taxable amount to be added is the taxable capital gain on the sale of the land of $1,250,000. The taxable capital gain on the sale of the building and the recapture will be deferred by deducting it from the cost of the new building. Therefore, these two amounts are not included in income for 2005.
|Less taxable Gain||(1,250,000)|
|Deferred Capital Gain and Recapture ($500,000+$1,173,000)||$1,673,000|
|Permanent differences calculated above ($1,250,000+$500,000)||1,750,000|
|Tax basis of the capital assets (building):UCC||$2,827,000|
|Carrying Value of the building (NBV)||(2,200,000)|
|Temporary differences (taxable)||627,000|
|Reconciliation of the difference||$4,050,000|
The company is entitled to defer all taxable capital gain of $500,000 and the taxable recapture of $1,173,000 for tax purposes as a consequence of the purchase of replacement property. A note to the financial statements will be required to disclose this deferral. The tax basis for the building will be cost of $5,000,000, less $500,000 (taxable capital gain on sale of building), and less $1,173,000 (recapture), to equal $3,327,000.
Next we will calculate the accounting income subject to income tax, the taxable income, and the current taxes payable.
|Income for accounting purposes:|
|Accounting income before adjustments||$2,000,000|
|Accounting gain on sale of assets||5,300,000|
|Accounting income before tax||$7,100,000|
|Non taxable gain (half of capital gain)||(1,750,000)|
|Accounting income subject to tax||$5,350,000|
|Accounting gain on sale of assets|
|Taxable gain on sale of land||1,250,000|
|Income Tax payable||$680,000|
|Less: Investment tax credit||(300,000)|
Product Development Expenses: Computations
|Deferred development expenses||$1,000,000|
|Investment Tax Credit||$700,000|
|Deferred Tax Credit|
|Deferred deduction/deferred for accounting||$1,000,000|
|Future Income Tax Liability ($1,000,000 x 40%)||$400,000|
The balance sheet will show deferred development expenses of $700,000. The net amount will be amortized on the basis selected for development costs. The $400,000 will be added to the long-term future income tax liabilities on the balance sheet. This temporary difference will reverse as development costs are amortized.
The amount of investment tax credits recognized in the financial statements will be disclosed in the notes thereto.
The fact that development expenses have been written off for income tax purposes will be disclosed in the notes to the financial statements.
Investment Tax Credit: Computations
|Investment tax credit taxable next year||$300,000|
|Tax @ 40%||$120,000|
As the $300,000 will be taxable next year, the balance sheet will show a current deferred income tax credit of $120,000. This amount will reverse next year when the company will have to declare the income for tax purposes and pay the tax thereon.
The amount of $120,000 will be deducted from long-term future income tax liabilities on the balance sheet.
Balance in the building account at the end of 2004:
|Net book value ($2,200,000 + $200,000)||2,400,000|
|Future Income Tax balance||$170,800|
|(1) Tax Basis||(2) Carrying Value||(3)=(1)-(2) Temporary Difference Deductible (Taxable)||(4)=(3) x 40% Future Tax Asset (Liability) Year End||(5) Less Beginning Balance Dr (Cr)||(6)=(4)-(5) Adjustment For Current Year Dr (Cr)|
SUMMARY INCOME TAX JOURNAL ENTRY FOR 2005
|Income Tax Expense||1,960,000|
|Income Tax Payable||380,000|
|Future tax liability-building||760,000|
|Future tax liability-development expense||400,000|
|Future tax liability-deferred income tax credit||120,000|
|Deferred development expense||300,000|
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