Question

Part A: This year, Gumowski Company has each of the following items in its income statement.

1. Gross profits on installment sales.

2. Revenues on long-term construction contracts.

3. Estimated costs of product warranty contracts.

4. Premiums on officers’ life insurance policies with Gumowski as beneficiary.

Instructions

(b) Specify when deferred income taxes would need to be recognized for each of the items above, and indicate the rationale for such recognition.

Short answer

Item	Recognition of deferred income tax
1	Recognized when the gross profit is added to the pre-tax income.
2	Recognized when the revenue is used for reporting purposes.
3	Recognized usually.
4	Not recognized.

Step-by-step solution

Definition of Income Tax

Income tax can be defined as the fees paid by the earnings individual or business entity to the government or taxation authority. Such fees are paid as a specific percentage of the income earned above the limits established by the government.

Recognizing deferred income tax

1. Gross profit on installment sales: The business entity will recognize the deferred income tax on the gross profit from the installment sales when the business entity includes such gross profit in the pre-tax income.
2. Revenues on long-term construction contracts:The business entity will recognize deferred income tax for the revenue from the long-term contract whenever the revenue is recognized for reporting into the financial statement using a percentage of completion method but is deferred for tax accounting.
3. The estimated cost of product warranty contracts: The business entity must usually recognize the deferred income tax for estimated warranty cost because it recognizes the estimated warranty cost in the year of sale and reports for tax purposes when it is paid.
4. Premiums on officer’s life insurance policies with Gumowski as beneficiary: The business entity will not recognize deferred income tax because it is the permanent difference.