Final answer:
The correct journal entry for the deferred tax at the end of year 2 is $12,000, obtained by applying the 40% tax rate to the cash rental payments received in year 2 that are taxed but not yet recognized for accounting purposes.option c is correct answer.
Step-by-step explanation:
The student's question deals with deferred tax accounting due to timing differences between when rental income is taxed and when it is recognized in financial statements. Baskin's accounting income in year 2 is $100,000, with advance rental payments of $20,000 in year 1 and $30,000 in year 2 which are taxed when received. However, these will only be recognized in the financial statements as $25,000 in years 3 and 4.
Firstly, let's determine the total rental income that will be recognized for tax purposes by the end of year 2, which is $20,000 + $30,000 = $50,000. Since Baskin will recognize this income for financial reporting purposes evenly in year 3 and 4, the income reported for accounting purposes by the end of year 2 will be $0.
The difference between taxable income and accounting income for the rental payments by the end of year 2 is $50,000 (tax purposes) - $0 (accounting purposes) = $50,000. This creates a deferred tax liability because the income has been taxed but not yet recognized in the financial statements.
Applying the 40% tax rate to this $50,000 difference results in a deferred tax liability of 40% x $50,000 = $20,000. However, this question asks for the journal entry at the end of year 2, which only involves the change during year 2. We should consider the advance payment in year 2 only, which is $30,000. Applying the tax rate to this amount yields a potential deferred tax for year 2 as 40% x $30,000 = $12,000.
Therefore, the correct journal entry for the deferred tax at the end of year 2 is choice C) $12,000.