I have all the entries finished except this one attached in the photo. The information you’ll need is what is the photo attached in this email and income before income taxes = $11,615,274. Use MACRS to understand the book tax difference. Permanent book tax difference and deductibles are also necessary to complete this entry. Beginning deferred tax asset is debited for $3,500,000, and beginning deferred tax liability is credited for 270,000. These are critical, and the DTA and DTL could either be debited or credited in the entry. Future differences are also to be accounted for, and it is very important to note that depreciation started in 2021, not 2020. This is not specified in the question, but was told by my professor.
The correct answer and explanation is :
Here’s how to break down the necessary components and the journal entry:
Step-by-Step Process:
- Income Before Income Taxes:
- The income before taxes is $11,615,274, which is provided.
- MACRS Depreciation:
- Since depreciation started in 2021, MACRS will be applied based on the property and the depreciation schedule. Without specific details about the asset classes and lives, I’ll assume it’s standard depreciation.
- Permanent Book-Tax Differences:
- Permanent differences are usually items that will not reverse, such as fines, penalties, or tax-exempt income. These need to be factored in separately.
- Deferred Tax Asset (DTA) and Deferred Tax Liability (DTL):
- Beginning DTA: $3,500,000 (Debited)
- Beginning DTL: $270,000 (Credited) Adjustments for future differences must be considered, based on the tax rates and changes in depreciation, which affect both DTA and DTL.
- Tax Rate:
- The tax rate is crucial here, though it’s not mentioned. I’ll assume a standard tax rate of 21% for this explanation, unless otherwise stated.
Entry for Deferred Taxes:
We’ll start by adjusting for the MACRS depreciation difference and any future taxable differences. The DTA and DTL will change based on the differences between the book depreciation and the tax depreciation.
Let’s assume there’s a temporary difference in depreciation of $1,000,000, where tax depreciation exceeds book depreciation. This would lead to a deferred tax liability.
Adjustments for Deferred Tax Liability (DTL) and Deferred Tax Asset (DTA):
- DTL Adjustment: The difference between book depreciation and tax depreciation will affect the DTL.
- DTL = Temporary Difference × Tax Rate.
- Example: $1,000,000 × 21% = $210,000.
- Deferred Tax Asset (DTA) Adjustments:
- A DTA represents future tax benefits, and any deductible differences between book and tax treatments of items like expenses or provisions need to be adjusted.
Journal Entry:
- Debit: Deferred Tax Asset (DTA) – $3,500,000 (beginning balance)
- Credit: Deferred Tax Liability (DTL) – $270,000 (beginning balance)
- Debit/Credit: Adjustments for future temporary differences based on depreciation.
- For example, Debit DTA and Credit DTL for any adjustments.
- Final Balance:
The final balance of DTA and DTL would depend on the exact depreciation differences calculated using MACRS.
Explanation:
- Deferred Tax Assets and Liabilities:
DTA and DTL are created due to timing differences between book and tax depreciation. The DTL results from temporary differences in depreciation (using MACRS) which will reverse in future years. - MACRS Depreciation:
Under MACRS, depreciation is accelerated for tax purposes, meaning that tax depreciation exceeds book depreciation in the early years. This creates a DTL as taxes are deferred. - Permanent Differences:
These would be accounted for separately, as they do not reverse in future periods.
Without the exact figures from the photo (if any), this process provides a clear path to handling the deferred taxes and adjusting for the temporary differences due to depreciation.