Question

Wise Company began operations at the beginning of 2018. The following information pertains to this company. 1. Pretax financial income for 2018 is \(100,000. 2. The tax rate enacted for 2018 and future years is 40%. 3. Differences between the 2018 income statement and tax return are listed below: (a) Warranty expense accrued for financial reporting purposes amounts to \)7,000. Warranty deductions per the tax return amount to \(2,000. (b) Gross profit on construction contracts using the percentage-of-completion method per books amounts to \)92,000. Gross profit on construction contracts for tax purposes amounts to \(67,000. (c) Depreciation of property, plant, and equipment for financial reporting purposes amounts to \)60,000. Depreciation of these assets amounts to \(80,000 for the tax return. (d) A \)3,500 fine paid for violation of pollution laws was deducted in computing pretax financial income. (e) Interest revenue recognized on an investment in tax-exempt municipal bonds amounts to $1,500. 4. Taxable income is expected for the next few years. (Assume (a) is short-term in nature; assume (b) and (c) are long-term in nature.) Instructions (a) Compute taxable income for 2018. (b) Compute the deferred taxes at December 31, 2018, that relate to the temporary differences described above. Clearly label them as deferred tax asset or liability. (c) Prepare the journal entry to record income tax expense, deferred taxes, and income taxes payable for 2018. (d) Draft the income tax expense section of the income statement, beginning with “Income before income taxes.”

Short answer

Financial reporting is the function of the finance department where all of the organization's transactions which involve inflow or outflow of money, are reported in its respective financial statements.

Step-by-step solution

(a) Computation of taxable income

Particulars	Amount
Financial Income	$100,000
Add: Fine for pollution	$3,500
Less: Interest	$1,500
Add: Excess warranty	$5,000
Less: Excess construction profit	$25,000
Less: Excess depreciation	$20,000
Taxable Income	$62,000

(b) Computation of deferred taxes

Temporary difference	Taxable amount	Tax rate	Deferred tax asset	Deferred tax liability
Warranty costs	($5,000)	40%	($2,000)
Construction profits	$25,000	40%		$10,000
Depreciation	$20,000	40%		$8,000
Totals	$40,000		($2,000)	$18,000

(c) Journal Entry

Wise Company
Journal Entry
Date	Particulars	Debit	Credit
2018	Income tax expense	$41,600
	Deferred tax asset	$1,200
	Deferred tax liability		$18,000
	Income tax payable		$24,800
	(To record the tax expense)

(d) Income tax expense section

Wise Company
Income Statement
Particulars		Amount
Income before income taxes		$100,000
Less: Income tax expense
Current	$24,800
Deferred	$16,800	$41,600
Net Income		$58,400