Question

The following facts relate to Duncan Corporation. 1. Deferred tax liability, January 1, 2017, \(60,000. 2. Deferred tax asset, January 1, 2017, \)20,000. 3. Taxable income for 2017, \(105,000. 4. Cumulative temporary difference at December 31, 2017, giving rise to future taxable amounts, \)230,000. 5. Cumulative temporary difference at December 31, 2017, giving rise to future deductible amounts, $95,000. 6. Tax rate for all years, 40%. No permanent differences exist. 7. The company is expected to operate profitably in the future. Instructions (a) Compute the amount of pretax financial income for 2017. (b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2017. (c) Prepare the income tax expense section of the income statement for 2017, beginning with the line “Income before income taxes.” (d) Compute the effective tax rate for 2017.

Short answer

Deductibles are the amount that an organization can claim while filing their income tax return. It helps the organization in decreasing its total income tax expense.

Step-by-step solution

Computation of originating difference

Particulars	Amount
Cumulative temporary difference at the end	$230,000
Less: Cumulative temporary difference at the beginning $\left(\frac{\$60,000}{40\%}\right)$	$150,000
Originating difference in 2017 (taxable)	$80,000

Particulars	Amount
Cumulative temporary difference at the end	$95,000
Less: Cumulative temporary difference at the beginning $\left(\frac{\$20,000}{40\%}\right)$	$50,000
Originating difference in 2017 (deductible)	$45,000

(a) Computation of financial income for 2017.

Particulars	Amount
Originating difference in 2017 (taxable)	$80,000
Less: Originating difference in 2017 (deductible)	$45,000
Add: Taxable income for 2017	$105,000
Pretax financial income for 2017	$140,000

(b) Preparation of the journal entry

Date	Particulars	Debit	Credit
2017	Income tax expense $\left(\$105,000\times 40\%\right)$	$42,000
	Income tax payable		$42,000
	(To record the income tax expense)
2017	Deferred tax asset	$20,000
	Profit and loss		$20,000
	(To record the deferred tax asset)
2017	Profit and loss	$60,000
	Deferred tax liability		$60,000
	(To record the deferred tax liability)

(c) Preparation of the income statement

Income Statement
Particulars		Amount
Income before income taxes		$140,000
Less: Income tax expense
Current expense	$42,000
Deferred expense	$14,000	$56,000
Net Income		$84,000

(d) Computation of effective tax rate

$\begin{array}{rcl}\mathbf{Effective}\mathbf{}\mathbf{tax}\mathbf{}\mathbf{rate}& \mathbf{=}& \left(\frac{\mathrm{Incom}\mathrm{tax}\mathrm{expense}}{\mathrm{Income}\mathrm{before}\mathrm{income}\mathrm{tax}}\right)\\ & \mathbf{=}& \left(\frac{\$56,000}{\$140,000}\right)\\ & \mathbf{=}& \mathbf{40}\mathbf{\%}\end{array}$