Question

Accounting, Analysis, and Principles DeJohn Company, which began operations at the beginning of 2015, produces various products on a contract basis. Each contract generates a gross profit of \(80,000. Some of DeJohn’s contracts provide for the customer to pay on an installment basis. Under these contracts, DeJohn collects one-fifth of the contract revenue in each of the following four years. For financial reporting purposes, the company recognizes gross profit in the year of completion (accrual basis). For tax purposes, DeJohn recognizes gross profit in the year cash is collected (installment basis). Presented below is information related to DeJohn’s operations for 2017:

1. In 2017, the company completed seven contracts that allow for the customer to pay on an installment basis. DeJohn recognized the related gross profit of \)560,000 for financial reporting purposes. It reported only \(112,000 of gross profit on installment sales on the 2017 tax return. The company expects future collections on the related installment receivables to result in taxable amounts of \)112,000 in each of the next four years.
2. In 2017, nontaxable municipal bond interest revenue was \(28,000.
3. During 2017, nondeductible fines and penalties of \)26,000 were paid.
4. Pretax financial income for 2017 amounts to $500,000.
5. Tax rates (enacted before the end of 2017) are 50% for 2017 and 40% for 2018 and later.
6. The accounting period is the calendar year.
7. The company is expected to have taxable income in all future years.
8. The company has no deferred tax assets or liabilities at the end of 2016.

Accounting

Prepare the journal entry to record income taxes for 2017.

Analysis

Classify deferred income taxes on the balance sheet at December 31, 2017, and indicate, starting with Income before income taxes, how income taxes are reported on the income statement. What is DeJohn’s effective tax rate?

Principles

Explain how the conceptual framework is used as a basis for determining the proper accounting for deferred income taxes.

Short answer

• Income tax expense is debited by$164,200, and Income taxes payable is credited by $ 25,000 and Deferred tax liability $139,200.
• The effective tax rate is 32.84%.
• Deferred tax assets and liabilities must be reported according to this conceptual framework.

Step-by-step solution

(a) Explaining the Accounting

Taxable income for 2015:

Pretax financial income for 2015	$500,000
Permanent difference:
Non-taxable revenue-government bond interest $(28,000)
Non-deductible expenses-fines and penalties of 26,000	(2,000)
	498,000
Temporary differences:
Excess gross profit per books	(448,000)
Taxable Income for 2015	$ 50,000
Income tax rate	50%
Income tax payable	$25,000

Adler has future amounts arising from temporary differences as follows:

Year	Future taxable amount	Tax rate	Deferred tax
2016	$112,000	0.40	$ 44,800
2017	112,000	0.40	44,800
2018	112,000	0.40	44,800
2019	112,000	0.40	44,800
			$179,200

The $179,200 is a deferred tax liability because the temporary difference is from future taxable amounts.

Additional tax liability needed is $19,200 ($179,200$40,000)

Preparing journal entry

Date	Particulars	Debit ($)	Credit ($)
	Income tax expense	164,200
	Income taxes payable		25,000
	Deferred tax liability		139,200

(b) Explaining the Analysis

The deferred tax amount of $179,200 would be categorized as a non-current liability. The payment of income taxes would be considered a current responsibility.

The income statement's income tax expense portion may look as follows:

Income before income taxes	$500,000
Income tax expense:
Current $ 25,000
Deferred 139,200	164,200
Net Income	$335,800

Adler’s 2015 effective tax rate is:

$\begin{array}{c}\mathbf{Effective}\mathbf{tax}\mathbf{rate}\mathbf{=}\frac{\mathbf{Income}\mathbf{tax}\mathbf{expense}}{\mathbf{Income}\mathbf{before}\mathbf{income}\mathbf{taxes}}\\ \mathbf{=}\frac{\$164,200}{\$500,000}\\ \mathbf{=}\mathbf{0}\mathbf{.}\mathbf{3284}\mathbf{or}\mathbf{32}\mathbf{.}\mathbf{84}\mathbf{\%}\end{array}$

(c) Explaining the Principles

Deferred taxes should be recorded as assets and liabilities, according to the Conceptual Framework. The Conceptual Framework clarifies how assets and liabilities should be defined.