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 :
To address the accounting entries related to the provided financial information, we need to analyze the book-tax differences, focusing on depreciation methods, and determine the necessary adjustments for deferred tax assets (DTA) and deferred tax liabilities (DTL).
1. Income Before Income Taxes:
The reported income before income taxes is $11,615,274.
2. Depreciation Methods and Book-Tax Differences:
The company utilizes the Modified Accelerated Cost Recovery System (MACRS) for tax purposes, which allows for accelerated depreciation compared to the straight-line method often used for financial reporting. This discrepancy creates temporary differences between book and tax depreciation, leading to deferred tax implications.
3. Permanent vs. Temporary Differences:
- Permanent Differences: These are differences that will not reverse over time and do not result in deferred tax assets or liabilities. Examples include fines or penalties that are recognized for book purposes but are not deductible for tax purposes.
- Temporary Differences: These differences arise when income or expenses are recognized in different periods for book and tax purposes. Depreciation differences between MACRS and the straight-line method are typical temporary differences.
4. Deferred Tax Asset (DTA) and Deferred Tax Liability (DTL):
Given the beginning balances—a DTA of $3,500,000 (debit) and a DTL of $270,000 (credit)—we need to adjust these accounts based on the current year’s book-tax differences.
5. Accounting Entries:
To record the income tax expense and adjust the DTA and DTL, the following journal entry is proposed:
- Debit: Income Tax Expense $2,439,208
- Credit: Deferred Tax Asset $1,000,000
- Credit: Deferred Tax Liability $1,439,208
Explanation:
- Income Tax Expense: Calculated by applying the tax rate (21%) to the income before taxes: $11,615,274 * 21% = $2,439,208.
- Deferred Tax Asset (DTA): Represents future tax benefits due to deductible temporary differences, such as expenses recognized for book purposes but not yet deductible for tax purposes.
- Deferred Tax Liability (DTL): Represents future tax obligations arising from taxable temporary differences, like accelerated depreciation for tax purposes.
This entry ensures that the income tax expense reflects both current tax obligations and adjustments to deferred tax accounts, aligning with the accrual basis of accounting for income taxes.