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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

Question: Novotna Inc.鈥檚 only temporary difference at the beginning and end of 2016 is caused by a \(3 million deferred gain for tax purposes for an installment sale of a plant asset, and the related receivable (only one-half of which is classified as a current asset) is due in equal installments in 2017 and 2018. The related deferred tax liability at the beginning of the year is \)1,200,000. In the third quarter of 2016, a new tax rate of 34% is enacted into law and is scheduled to become effective for 2018. Taxable income for 2016 is $5,000,000, and taxable income is expected in all future years.

Instructions

(a) Determine the amount reported as a deferred tax liability at the end of 2016. Indicate proper classification(s).

(b) Prepare the journal entry (if any) necessary to adjust the deferred tax liability when the new tax rate is enacted into law.

(c) Draft the income tax expense portion of the income statement for 2016. Begin with the line 鈥淚ncome before income taxes.鈥� Assume no permanent differences exist.

The amount of income taxes due to the government for a period of time is rarely the amount reported on the income statement for that period as income tax expense. (b) Explain the basic principles that are applied in accounting for income taxes at the date of the financial statements to meet the objectives discussed in (a).

Conlin Corporation had the following tax information. Year Taxable Income Tax Rate Taxes Paid 2015 \(300,000 35% \)105,000 2016 325,000 30 97,500 2017 400,000 30 120,000 In 2018, Conlin suffered a net operating loss of $480,000, which it elected to carry back. The 2018 enacted tax rate is 29%. Prepare Conlin鈥檚 entry to record the effect of the loss carryback.

The accounting records of Shinault Inc. show the following data for 2017 (its first year of operations).

1. Life insurance expense on officers was \(9,000.

2. Equipment was acquired in early January for \)300,000. Straight-line depreciation over a 5-year life is used with no salvage value. For tax purposes, Shinault used a 30% rate to calculate depreciation.

3. Interest revenue on State of New York bonds totaled \(4,000.

4. Product warranties were estimated to be \)50,000 in 2017. Actual repair and labor costs related to the warranties in 2017 were \(10,000. The remainder is estimated to be paid evenly in 2018 and 2019.

5. Gross profit on an accrual basis was \)100,000. For tax purposes, \(75,000 was recorded on the installment-sales method.

6. Fines incurred for pollution violations were \)4,200.

7. Pretax financial income was $750,000. The tax rate is 30%.

Instructions (a) Prepare a schedule starting with pretax financial income in 2017 and ending with taxable income in 2017. (b) Prepare the journal entry for 2017 to record income taxes payable, income tax expense, and deferred income taxes.

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�
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