SAMPLE DEFERRED TAX PROBLEM

Desserts Inc. began business on January 1, 20X6.

Its pretax
financial income (book income) for the first two years was as
follows:
20X6
$50,000
20X7
$120,000
The following items caused the only differences between pretax
financial income and taxable income:
1.

The company has chosen to depreciate all of its depreciable

assets on an accelerated basis for tax purposes but on a
straight-line basis for accounting purposes.
This resulted
in tax depreciation exceeding book depreciation by $27,000 in
20X6.
This difference will reverse equally over the three
year period 20X7 20X9.

2.

In 20X6 the company paid $30,000 for insurance premiums on

key officers and is amortizing this amount on the books over
10 years (a full year's amortization was taken in 20X6).
These premiums are not deductible for tax purposes.

3.

In 20X7 the company terminated a top executive and agreed to

$24,000 of severance pay. The amount will be paid $8,000 per
year for 20X7-X9.
The 20X7 payment was made.
The $24,000
was expensed for book purposes in 20X7.
For tax purposes,
the severance pay is deductible when it is paid.

The enacted tax rates existing at December 31, 20X6 are:

20X6
40%
20X7
35%
20X8
30%
20X9
30%
REQUIRED:
A.

Determine taxable income for 20X6 and 20X7.

B.

Determine the required balance of deferred income taxes at

the end of 20X6, and prepare the journal entry to record
income taxes for 20X6. Skip dates and explanations.

C.

Prepare the income tax section of the income statement for

20X6, beginning with "Income from operations before taxes".

D.

Compute the required balances in the Deferred Tax Asset and

Deferred Tax Liability accounts at the end of 20X7.

E.

Show how the Deferred Taxes will be shown on the 12/31/X7

balance sheet.
Give financial statement classification,
presentation, and amount.