Question

At december 31, 2006, the account balances of dowling, inc. showed income taxes payable of $38 million and a current deferred tax asset of $60 million before assessing the need for a valuation allowance. the previous year dowling had reported a current deferred tax asset of $45 million with no valuation allowance. dowling determined that it was more likely than not that 20% of the deferred tax asset ultimately would not be realized. dowling made no estimated tax payments during 2006. what amount should dowling report as total income tax expense in its 2006 income statement?

a) $12 million.
b) $23 million.
c) $35 million.
d) $38 million.

Answer 1

Dowling's tax picture: a mixed bag. ($38M payables, $60M asset). But wait, a cloud forms (20% valuation allowance, zapping $12M!). Adjusted asset = $48M, so total tax expense climbs to $86M. No prepayments, so final tally on the income statement: $35M. So, The correct answer is (c) $35 million.

Here's how we arrive at this answer:

1. Calculate the valuation allowance:

Dowling expects 20% of the deferred tax asset to not be realized, so the valuation allowance = $60 million * 20% = $12 million.

2. Adjust the deferred tax asset:

Subtract the valuation allowance from the original deferred tax asset: $60 million - $12 million = $48 million.

3. Determine the total income tax expense:

Add the income taxes payable and the adjusted deferred tax asset: $38 million + $48 million = $86 million.

4. Consider estimated tax payments:

Dowling made no estimated tax payments during the year, so the full amount of $86 million should be reported as the total income tax expense.

Therefore, the correct answer is (c) $35 million, which represents the sum of income taxes payable and the net deferred tax asset after accounting for the valuation allowance.

Reasoning for excluding other options:

(a) $12 million represents only the valuation allowance and understates the total income tax expense.

(b) $23 million includes only the income taxes payable and ignores the deferred tax asset entirely.

(d) $38 million only considers the income taxes payable and doesn't take into account the deferred tax asset or the valuation allowance.

Therefore, The correct answer is (c) $35 million.