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Fundamentals of Tax Accruals |
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Example 1 – Deferred Tax Liability
Assume that at the end of year 1, Bizzer Corporation has pre-tax book income of $5,000. There are no permanent differences, but the company included in its financial statement income an installment receivable (gain of $1,500) that will be paid out over the next 5 years ($300 gain per year). Assume the enacted tax rate for years 1 through 4 is 30% and in year 5 it jumps to 40%. Calculate the tax provision for Bizzer Corporation for Year 1.
Solution:
Under the liability method, the tax provision for the corporation is the sum of the federal taxes due for the current year; plus or minus any deferred taxes.
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Step 1: Calculate the Current Tax Liability |
| Pretax Book Income |
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$5,000
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| +/- Permanent Differences |
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-0- |
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| +/- Timing Differences |
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<1,500>
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(gain to be reported in the future) |
| Taxable Income |
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$3,500
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Tax Due (30% of $3,500) |
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$1,050
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Step 2: Calculate the Deferred Tax Liability |
Spreading the temporary differences to each of their reversing years completes this task.
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Year 2 |
Year 3 |
Year 4 |
Year 5 |
Year 6 |
| Installment Receivable |
$ 300
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300
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300
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300
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300
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| Total Entries by Year |
$ 300
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300
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300
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300
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300
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| Tax Rate by Year |
30% |
30% |
30% |
40% |
40% |
| Annual Deferred Tax Liability |
$ 90
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90
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90
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120
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120
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Therefore, under the measurement rules, the deferred tax liabilty is the sum of the reversing temporary differences or $510 ($90+90+90+120+120)
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Step 3: Calculate the Provision |
Adding together the current and deferred liabilities.
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Financial
Tax Provision |
= |
Current
Tax Liability |
+ |
Deferred
Taxes Liability |
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? |
= |
$1,050 |
+ |
$510 |
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Accordingly, the tax provision for Bizzer Corporation is $1,560 ($1,050 + 510).
The journal entry to record this transaction would look like this:
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Using the tax accounting principles in effect prior to SFAS 109 would have yielded a tax expense of $1,500 (30% of $5,000). The only difference between the prior rules and the current rules can be attributed to the tax rate change that occurred in year 5. If it had not been for the rate change, either set of rules would have yielded the same result. See if you agree. |
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Copyright © 1998 Bizzer Professional Training |
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