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Chapter 19: Q7CA (page 1107)

(Deferred Taxes, Income Effects) Stephanie Delaney, CPA, is the newly hired director of corporate taxation for Acme Incorporated, which is a publicly traded corporation. Ms. Delaney鈥檚 first job with Acme was the review of the company鈥檚 accounting practices on deferred income taxes. In doing her review, she noted differences between tax and book depreciation methods that permitted Acme to realize a sizable deferred tax liability on its balance sheet. As a result, Acme paid very little in income taxes at that time.

Delaney also discovered that Acme has an explicit policy of selling off plant assets before they reversed in the deferred tax liability account. This policy, coupled with the rapid expansion of its plant asset base, allowed Acme to 鈥渄efer鈥� all income taxes payable for several years, even though it always has reported positive earnings and an increasing EPS. Delaney checked with the legal department and found the policy to be legal, but she鈥檚 uncomfortable with the ethics of it.

Instructions

Answer the following questions.

  1. Why would Acme have an explicit policy of selling plant assets before the temporary differences reversed in the deferred tax liability account?
  2. What are the ethical implications of Acme鈥檚 鈥渄eferral鈥� of income taxes?
  3. Who could be harmed by Acme鈥檚 ability to 鈥渄efer鈥� income taxes payable for several years, despite positive earnings?
  4. In a situation such as this, what are Ms. Delaney鈥檚 professional responsibilities as a CPA?

Short Answer

Expert verified
  1. Acme must have employed accelerated depreciation for tax purposes but straight-line depreciation for financial accounts.
  2. Acme looks to be lowering its taxes using a totally lawful tax strategy plan.
  3. Acme's income tax approach might affect the federal government.
  4. Stephanie has a responsibility to maintain objectivity and honesty when it comes to financial reporting.

Step by step solution

01

Meaning of Income-tax payable

A business's tax responsibility to the government in which it operates is known as "income tax payable."

02

(a) Explaining why Acme has an explicit policy.

Acme adopted an accelerated depreciation technique for tax reasons while utilizing straight-line depreciation for its financial statements torealize a significant deferred tax liability.

Taxable income would surpass financial accounting income after the temporary discrepancy was corrected. Acme would have to pay the taxes it "delayed" in years where tax depreciation exceeded book depreciation.

Acme would have to sell these plant assets to prevent this from happening. It would be again on sale, but it would almost certainly be taxed at the lower capital gains rates. Acme will continue a "deferral" of income taxes if it purchases new plant assets and employs accelerated depreciation for tax reasons and straight-line for books.

03

(b) Explaining the ethical implications of Acme’s.

Deferring income taxes indicates that a corporation will be able to delay paying its income taxes (or reaping an income tax benefit) until future periods due to transitory variations created by changes in financial accounting rules and tax legislation. The practice of selling assets before the temporary difference disappears implies the corporation will pay less tax to the government.

While some may be worried that Acme is not paying its "fair share," the company appears to be lowering its taxes using a legal tax strategy plan. The taxation body has decided to grant these benefits, and there is nothing wrong with postponing the payment.

04

(c) Explaining the person harmed by Acme’s ability to “defer” income taxes payable for several years.

The federal government, which gets lower taxes due to Acme's income tax strategy, is the key stakeholder who might be damaged. Other taxpayers will have to pay more in the end. Furthermore, if acquiring new plant assets is prohibitively expensive, positive cash flow diminishes. Investors and creditors are harmed, even though the impact should be minimal.

05

(d) Explaining Ms. Delaney’s professional responsibilities as a CPA.

Stephanie is required to maintain objectivity and honesty in the conduct of financesas a public accountant. If she believes this practice is unethical, she should raise her concerns with Acme's senior management, including the Board of Directors and the Audit Committee members. However, Acme is only attempting to reduce its income taxes, which should not be regarded as immoral.

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Most popular questions from this chapter

Meyer reported the following pretax financial income (loss) for the years 2015鈥�2019. 2015 $240,000 2016 350,000 2017 120,000 2018 (570,000) 2019 180,000 Pretax financial income (loss) and taxable income (loss) were the same for all the years involved. The enacted tax rate was 34% for 2015 and 2016, and 40% for 2017鈥�2019. Assume the carryback provision is used for the net operating losses. Instructions (a) Prepare the journal entries for the years 2017鈥�2019 to record the income tax expense, income taxes payable (refundable), and the tax effects of the loss carryback and loss carryforward, assuming that based on the weight of available evidence, it is more likely than not that one-fifth of the benefits of the loss carryforward will not be realized. (b) Prepare the income tax section of the 2018 income statement beginning with the line 鈥淚ncome (loss) before income taxes.鈥�

What is the difference between a future taxable amount and a future deductible amount? When is it appropriate to record a valuation account for a deferred tax asset?

Under IFRS: (a) 鈥減robable鈥� is defined as a level of likelihood of at least slightly more than 60%. (b) a company should reduce a deferred tax asset when it is likely that some or all of it will not be realized by using a valuation allowance. (c) a company considers only positive evidence when determining whether to recognize a deferred tax asset. (d) deferred tax assets must be evaluated at the end of each accounting period.

The following information has been obtained for Gocker Corporation.

1. Prior to 2017, taxable income and pretax financial income were identical.

2. Pretax financial income is \(1,700,000 in 2017 and \)1,400,000 in 2018.

3. On January 1, 2017, equipment costing \(1,200,000 is purchased. It is to be depreciated on a straight-line basis over 5 years for tax purposes and over 8 years for financial reporting purposes. (Hint: Use the half-year convention for tax purposes, as discussed in Appendix 11A.)

4. Interest of \)60,000 was earned on tax-exempt municipal obligations in 2018.

5. Included in 2018 pretax financial income is a gain on discontinued operations of $200,000, which is fully taxable.

6. The tax rate is 35% for all periods.

7. Taxable income is expected in all future years.

Instructions (a) Compute taxable income and income taxes payable for 2018. (b) Prepare the journal entry to record 2018 income tax expense, income taxes payable, and deferred taxes. (c) Prepare the bottom portion of Gocker鈥檚 2018 income statement, beginning with 鈥淚ncome from continuing operations before income taxes.鈥� (d) Indicate how deferred income taxes should be presented on the December 31, 2018, balance sheet.

Beilman Inc. reports the following pretax income (loss) for both book and tax purposes. (Assume the carryback provision is used where possible for a net operating loss.) Year Pretax Income (Loss) Tax Rate 2015 $120,000 40% 2016 90,000 40 2017 (280,000) 45 2018 120,000 45 The tax rates listed were all enacted by the beginning of 2015.Instructions (a) Prepare the journal entries for years 2015鈥�2018 to record income tax expense (benefit) and income taxes payable (refundable), and the tax effects of the loss carryback and loss carryforward, assuming that based on the weight of available evidence, it is more likely than not that one-half of the benefits of the loss carryforward will not be realized. (b) Prepare the income tax section of the 2017 income statement beginning with the line 鈥淥perating loss before income taxes.鈥� (c) Prepare the income tax section of the 2018 income statement beginning with the line 鈥淚ncome before income taxes.鈥�
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