Question

Bronson Industries reported a deferred tax liability of $13.2 million for the year ended December 31, 2017, related to a temporary difference of $33 million. The tax rate was 40%. The temporary difference is expected to reverse in 2019 at which time the deferred tax liability will become payable. There are no other temporary differences in 2017–2019. Assume a new tax law is enacted in 2018 that causes the tax rate to change from 40% to 30% beginning in 2019. (The rate remains 40% for 2018 taxes.) Taxable income in 2018 is $43 million.

Required:
a. Determine the effect of the change and prepare the appropriate journal entry to record Bronson's income tax expense in 2016.
b. What adjustment, if any, is needed to revise retained earnings as a result of the change?

Answer 1

Income tax payable 2018 = $43 x 40% = $17.2 million

deferred tax liability = temporary difference x change in income taxes = $33 million x (40% - 30%) = $3.3 million

income tax expense = income tax payable - deferred tax liability = $17.2 million - $3.3 million = $13.9 million

a. Determine the effect of the change and prepare the appropriate journal entry to record Bronson's income tax expense in 2016.

• Dr Income tax expense 13,900,000
• Dr Deferred tax liability 3,300,000
• Cr Income tax payable 17,200,000

b. What adjustment, if any, is needed to revise retained earnings as a result of the change?

• Deferred tax assets and liabilities affect the current retained earnings, but no adjusting entry is needed.
• Deferred tax assets and liabilities result in differences between US GAAP rules and the rules that the accounting rules used by the IRS (e.g. expensing asset purchases). Generally the greatest effects of deferred tax assets and liabilities are seen in the cash flow statements, not retained earnings.