Question

Southern Atlantic Distributors began operations in January 2021 and purchased a delivery truck for $40,000. Southern Atlantic plans to use straight-line depreciation over a four-year expected useful life for financial reporting purposes. For tax purposes, the deduction is 50% of cost in 2021, 30% in 2022, and 20% in 2023. Pretax accounting income for 2021 was $300,000, which includes interest revenue of $40,000 from municipal governmental bonds. The enacted tax rate is 25%.

Assuming no differences between accounting income and taxable income other than those described above:
Required:
What Southern Atlantic's 2021 net income?

Answer 1

Southern Atlantic's 2021 net income is calculated by adjusting pretax accounting income for tax-exempt interest and differences in depreciation. The taxable income after adjustments is $250,000, and with a 25% tax rate, income tax expense is $62,500. The net income for 2021 is therefore $237,500.

Step-by-step explanation:

To calculate Southern Atlantic's 2021 net income, we must first adjust the pretax accounting income for the tax-exempt interest revenue and the difference in depreciation methods for accounting and tax purposes. The interest revenue from municipal bonds is tax-exempt, so we should exclude this when calculating the income tax expense.

The accounting depreciation is $10,000 per year ([$40,000 purchase price] / [4-year useful life]). For tax purposes, the depreciation is 50% of the cost in 2021, which is $20,000 ($40,000 * 50%). Therefore, the difference in depreciation is $10,000 ($20,000 - $10,000) and represents a temporary difference that will reverse in future years.

The taxable income for 2021 would be the pretax accounting income of $300,000 minus the tax-exempt interest revenue of $40,000 and adjusted for the temporary difference in depreciation ($10,000), which equates to $250,000. The income tax expense is 25% of the $250,000 taxable income, which is $62,500. Therefore, Southern Atlantic’s 2021 net income is the pretax accounting income of $300,000 minus the income tax expense of $62,500, resulting in $237,500.

Answer 2

1. Dr Income tax expense $43,000

Cr Deferred tax liability $2,500

Cr Income tax payable $40,500

2. $157,000

Step-by-step explanation:

1. Preparation of the Journal entry to record income taxes in 2021

First step is to record income taxes in 2021

TAX RATE % TAX $ RECORDED AS

Pre-tax accounting income $200,000

Less Permanent difference ($28,000)

Income subject to Taxation

$172,000 ×25% $43,000 Income tax expense

Less Temporary difference

($10,000) ×25% - $2,500 Deferred tax liability

Income taxable in current year

$162,000 ×25% $40,500 Income tax payable

Calculation for Temporary difference

Depreciation in 2021 as per taxation=$40,000×50%

Depreciation in 2021 as per taxation=$20,000

Depreciation as per straight line=$40,000/4

Depreciation as per straight line=$10,000

Using this formula to calculate the Temporary difference

Temporary difference=Depreciation as per straight line-Depreciation in 2021 as per taxation

Let plug in the formula

Temporary difference=$20,000-$10,000

Temporary difference=$10,000

Preparation of Southern Atlantic Distributors JOURNAL ENTRY

Dr Income tax expense $43,000

Cr Deferred tax liability $2,500

Cr Income tax payable $40,500

(Being to record income tax expense)

2. Calculation for Southern Atlantic Distributors Net income

Income before income taxes $200,000

Less Income tax expense

Deferred tax liability ($2,500)

Income tax payable ($40,500)

Net income $157,000

($200,000-$2,500-$40,500)

Therefore 2021 Net income is $157,000

hope this help