Final answer:
Arnold Industries must calculate taxable income by considering the advance lease payment that is tax-deductible in 2021 for tax purposes but not for accounting purposes. The tax expense is calculated using a 25% rate for 2021 and 2022, and the journal entries for income taxes reflect these calculations.
Step-by-step explanation:
Arnold Industries has a pretax accounting income of $32 million for the year ended December 31, 2021, and a tax rate of 25%. With an $8 million pretax lease payment made, which is deductible for tax but not for accounting, we need to calculate the taxable income and corresponding tax expense, as follows:
- Pretax accounting income: $32,000,000
- Lease payment (tax-deductible): ($8,000,000)
- Taxable income: $24,000,000
- Tax expense (25% of taxable income): $6,000,000
- Deferred tax asset (25% of lease payment): $2,000,000
The journal entry to record 2021 taxes would be a debit to the income tax expense for $6 million, a debit to the deferred tax asset for $2 million, and a credit to income tax payable for $6 million.
For 2022:
- Pretax accounting income: $50,000,000
- Lease payment expensed for accounting in 2022: $2,000,000 (1/4th of $8 million)
- Taxable income: $50,000,000 (no additional lease payment deducted in 2022)
- Tax expense (25% of taxable income): $12,500,000
- Deferred tax asset to reverse (1/4th of $2 million): $500,000
The journal entry to record Arnold's income taxes for 2022 would be a debit to income tax expense for $12,500,000, a credit to deferred tax asset for $500,000, and a credit to income tax payable for $12,000,000. With the new tax law enacted in 2022 that changes the tax rate to 15% beginning in 2023, the company will need to adjust its deferred tax assets and liabilities. The new journal entry will include this change in tax rate.