Question

Problem 16-3 (Algo) Change in tax rate; single temporary difference (L016-2, 16-6] Dixon Development began operations in December 2021. When lots for industrial development are sold, Dixon recognizes income for financial reporting purposes in the year of the sale. For some lots, Dixon recognizes income for tax purposes when collected. Income recognized for financial reporting purposes in 2021 for lots sold this way was $10 million, which will be collected over the next three years. Scheduled collections for 2022–2024 are as follows: 2022 2023 2024 $ 4 million 4 million 2 million $ 10 million Pretax accounting income for 2021 was $15 million. The enacted tax rate is 30%. Required: 1. Assuming no differences between accounting income and taxable income other than those described above, prepare the journal entry to record income taxes in 2021. 2. Suppose a new tax law, revising the tax rate from 30% to 25%, beginning in 2023, is enacted in 2022, when pretax accounting income was $12 million. No 2022 lot sales qualified for the special tax treatment. Prepare the appropriate journal entry to record income taxes in 2022. 3. If the new tax rate had not been enacted, what would have been the appropriate balance in the deferred tax liability account at the end of 2022?

Answer 1

The response includes the calculation of income taxes for Dixon Development for 2021, taking into account the deferred taxes on uncollected revenue, and the adjustment needed for changes in tax law in 2022, as well as the determination of deferred tax liability if the tax rate had remained constant.

Step-by-step explanation:

Responding to the question involves calculating the income taxes for Dixon Development and making the necessary journal entries. The main tasks include calculating the tax expenses for 2021, adjusting for a change in the tax rate in 2022, and determining the deferred tax liability at the end of 2022 if the tax rate had not changed.

1. For 2021, the journal entry to record income taxes should reflect the tax on the pretax accounting income and the deferred tax liability on the $10 million income recognized for financial reporting but not for tax purposes. As the tax rate is 30%, the total tax expense is 30% of $15 million, which equals $4.5 million. However, $3 million of the income will not be taxed until it is collected over the following three years. Therefore, the current tax expense is 30% of ($15 million - $10 million) and the deferred tax liability is 30% of $10 million.

2. In 2022, the tax law changes the tax rate to 25% starting in 2023. For 2022, the tax expense would be 30% of the pretax accounting income of $12 million with no additional deferred tax liability since there were no lot sales qualifying for special tax treatment in 2022.

3. If the new tax rate had not been enacted, the appropriate balance in the deferred tax liability account at the end of 2022 would be calculated by applying the existing 30% tax rate to the undistributed portion of the income -- which would be the $6 million to be collected in 2023 and 2024.

Answer 2

Dixon Development's income taxes calculation in 2021 involves recognizing a $4.5 million tax payable and a $3 million deferred tax liability due to the timing difference in income recognition. The journal entry for 2022 with a tax rate change includes income tax expense and taxes payable of $3.6 million, and a deferred tax liability adjustment of $0.5 million. Without the tax rate change, the deferred tax liability at the end of 2022 would have remained at $3 million.

Step-by-step explanation:

To address the student’s queries regarding Dixon Development's income taxes, let's go through each requirement step by step:

1. Journal Entry for 2021 (without tax rate change): In 2021, Dixon Development has a pretax accounting income of $15 million and has recognized $10 million in income for financial reporting purposes but not for tax purposes. At a 30% tax rate, the current tax expense is calculated on the entire $15 million, resulting in a tax payable of $4.5 million. The remaining $10 million, which will be collected in future years, creates a temporary difference. This results in a deferred tax liability ($10 million income x 30% tax rate) of $3 million. The journal entry would be a debit to income tax expense for $7.5 million, a credit to taxes payable for $4.5 million, and a credit to deferred tax liability for $3 million.
2. Journal Entry for 2022 (with tax rate change to 25% in 2023 onwards): In 2022, the enacted tax rate for future years changes from 30% to 25%. No income qualifies for special tax treatment in 2022, so the current tax expense would be based on the $12 million pretax income at the 30% rate, amounting to $3.6 million. However, the deferred tax liability must be adjusted to reflect the new tax rate of 25% that will be applied when future income is recognized for tax purposes. This would result in a deferred tax liability adjustment of ($10 million x (25%-30%)) which is a decrease of $0.5 million. The journal entry for 2022 would include a debit to income tax expense for $3.6 million, a credit to taxes payable for $3.6 million, and a debit to the deferred tax liability for $0.5 million to adjust the balance.
3. Deferred Tax Liability at the End of 2022 Without Tax Rate Change: If the tax rate change had not been enacted, the deferred tax liability would remain at the 30% rate. Since no sales in 2022 qualified for special tax treatment, the year-end balance in the deferred tax liability account for the future taxable amounts of $10 million would still be $3 million (30% of $10 million).