Checkers Corporation
Checkers Corporation had a tax liability for 20X7 of $20,000based on a tax rate of 40%, but the accounting staff needs yourhelp in determining the tax expense and deferred tax amounts for20X7. The enacted tax rates for the future periods are 35% for 20X8â 20Y2, and then 30% for 20Y3 â 20Y6. Checkers does not believethat temporary differences can be reasonably projected beyond thoseperiods. The taxable income for 20X8 was $100,000. Checkers alsoowned a 30% interest in Chess, which reported income of $50,000 and$60,000 in 20X7 and 20X8, respectively. Checkers received dividendsof $5,000 and $8,000 from Chess for 20X7 and 20X8, respectively.Checkers expects this pattern of earnings and dividends to continueover the next ten years, if not longer.
Checkers estimated warranty expense to be $7,500 in 20X7 and$10,000 in 20X8. Actual warranty cost for the two years was $6,000and $12,000, respectively. The bad debts expense recognized on theincome statement was $15,000 in 20X7 and $20,000 in 20X8. Actualbad debt write-offs per the tax return were $10,000 in 20X7 and$15,000 in 20X8.
On January 1, 20X8 Checkers also received $30,000 of rent inadvance covering a two-year rental agreement, and $5,000 forinterest income on municipal bonds (classified as held-to-maturitysecurities). The bonds mature in 20Y0.
Depreciation expense calculations for Checkers are asfollows:
Year Cost Recovery Depreciation Year Cost Recovery Depreciation20X7 $24,000 $10,000 20Y2 9,000 10,000 20X8 24,000 10,000 20Y38,500 10,000 20X9 17,000 10,000 20Y4 4,500 10,000 20Y0 12,00010,000 20Y5 ---- 10,000 20Y1 9,000 10,000 20Y6 ---- 10,000 (amountscontinue in next columns) Totals $ 108,000 $ 100,000
Key Terminology
Taxable Income: Income (per IRC) less deductions (per IRC) pertax return Tax Liability: Taxes owed to government per income taxreturn (based on Taxable Income) Net Income: Revenue minus expensesper GAAP Provision for Income Taxes or Income Tax Expense: Anincome statement amount determined based upon thetaxable/deductible GAAP components. Includes the amount currentlypayable per tax return (tax liability) plus/minus any deferredamounts computed per schedules. Deferred Income Taxes: Atheoretical/conceptual liability that will be paid, only if theentity continues to generate a profit
into the future continues as a going concern. Deferred taxes arenot a legal obligation.
Required:
1. Determine the tax expense and the deferred tax amounts for20X7 and 20X8. 2. Determine the tax liability amount for 20X8. 3.Prepare all necessary journal entries for the two year period (20X7â 20X8). 4. Prepare a partial income statement for 20X7 showingearnings before tax, provision for income tax, and net income. Agood example of this format would be schedule M-1 from a corporateincome tax return.
