Chapter 16, Problem 16.13P

1.

To determine

Multiple Temporary Difference

It is very unlikely to have a single temporary difference in any company. In that case, the same concept of temporary difference will be applicable for multiple temporary difference. In case of multiple temporary difference, we have to categorize all temporary difference into future taxable amount and future deductible amounts. The total amount of future taxable amounts multiplied by future tax rate will generate deferred tax liability and total amount of future deductible amount multiplied by future tax rate will generate deferred tax asset.

Deferred tax asset

When the Income Tax Expense account i.e. the estimated income tax amount is more than the outstanding amount of income tax i.e. the Income Tax Payable account, the difference is to be debited to Deferred Tax Asset account.

Deferred tax liability

When the Income Tax Expense account i.e. the estimated income tax amount is less than the outstanding amount of income tax i.e. the Income Tax Payable account, the difference is to be credited to Deferred Tax Liability account.

To determine:  The portion of tax benefit from tax free interest to be recognized by TD Inc. in its 2016 tax return.

Explanation of Solution

The taxable income of TD Inc. is reduced by $15 million interest, which reduces the tax payable amount for the year 2016.

The amount of tax benefit derived by tax free interest is calculated below.

$\begin{array}{c}\text{Amount of Tax benefit = Tax free interest amount × Tax rate}\\ \text{=}\text{\$15}\text{million}\text{×}\text{40\%}\\ \text{=}\text{\$6}\text{million}\end{array}$

2.

To determine

To determine:  The portion of tax benefit from tax free interest should be reported in financial statement.

Explanation of Solution

TD Inc. has not recognized any tax benefit in its financial statement due to “more likely than not” nature of transaction. It means TD Inc. assume that the interest is not taxable even if after the examination by tax authority.

Therefore, TD Inc. should record $6 million tax benefit (Calculated above) as liability for the potential additional tax. It should be reported as long-term liability because the determination probably will not be made within the coming year.

3.

To determine

To determine:  The amount of tax benefit from the tax treatment of plot sale.

Explanation of Solution

TD Inc. can defer its installment income i.e. $60 million for the tax purpose because installment income has not received in 2016, so it will not qualify for taxation until the amount is received.

$\begin{array}{c}\text{Amount of Tax benefit on installment income = Installment income × Tax rate}\\ \text{=}\text{\$60}\text{million}\text{×}\text{40\%}\\ \text{=}\text{\$24}\text{million}\end{array}$

The portion of the deferral can be treated as a deferred tax liability which is not associated with the uncertain tax position. As it is classified as “more likely than not” that TD Inc.’s position could be sustained upon examination. Hence, TD Inc. is required to determine the largest amount that has a greater than 50% likelihood of sustainability.

The following table (1) shows, that TD Inc. could choose $40 million for tax benefit from the plot sale as the cumulative percentage is 60% which is higher than 50%. Hence, TD Inc. could recognize a deferred tax liability of $16 million.

$\begin{array}{c}\text{Deferred tax liability = Qualifying installment sales × Tax rate}\\ \text{=}\text{\$40}\text{×}\text{40\%}\\ \text{=}\text{\$16}\end{array}$

Amount Qualifying for Installment Sales Treatment	Percentage Likelihood of Tax Treatment Being Sustained	Cumulative Likelihood of Tax Treatment Being Sustained
$60	20%	20%
50	20%	40%
40	20%	60%
30	20%	80%
20	20%	100%

Table (1)

The balance amount of   $8 million i.e. $\left(\text{\$24 million - \$16 million}\right)$ could not be shown as deferred tax liability, rather it can be treated as a liability associated with an uncertain tax position.

4.

To determine

To prepare:  The journal entry to record income taxes in 2016, assuming full recognition of the tax benefits in the financial statements.

Explanation of Solution

Step 1: Calculation of income tax payable and deferred tax liability

(Amounts in $ Million)

	Current Year	Future Taxable Amount
	2016	2017	2018	Total
Pretax accounting income	90
Non-temporary Difference:
Interest Income	(15)
Temporary Difference:
Plot Sales	(60)	36	24	60
Taxable income (tax return)	15
Enacted tax rate	$\times$ 40%			$\times$ 40%
Income Tax Payable (1)	6
Deferred Tax Liability				24

Table (2)

Step 2: Calculate desired balance of deferred tax liability

	$ in millions
Ending balance of deferred tax liability (2016)	$24
Less: Beginning balance	$0
Change needed to achieve desired balance (2)	$24

Table (3)

Journal entry for recording of income tax expense for the year 2016 is as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($) (in millions)	Credit ($) (in millions)
2016	Income Tax Expense (3)		30
	Income Tax Payable (1)			6
	Deferred Tax Liability (2)			24
	(To record the income tax in 2016)

Table (4)

Working Notes:

Compute income tax expense amount.

$\begin{array}{c}\text{Income tax expense = Income tax payable + Deferred tax liability}\\ \text{=}\text{\$6}\text{million}\text{+}\text{\$24}\text{million}\\ \text{=}\text{\$30}\text{million}\end{array}$ (3)

5.

To determine

To prepare:  The journal entry to record income taxes in 2016, assuming the recognition of tax benefits in the financial statements indicated in requirements 1-3.

Explanation of Solution

Step 1: Compute deferred tax liability

$\begin{array}{c}\text{Deferred tax liability = Qualifying installment sales × Tax rate}\\ \text{=}\text{\$40}\text{million}\text{×}\text{40\%}\\ \text{=}\text{\$16}\text{million}\end{array}$ (4)

Step 2: Compute the potential projected tax

Projected additional tax for interest = $\left(\text{\$15 × 40\%}\right)$  = $6 million

Projected additional tax for installment sale = $\left[\left(\text{\$60-\$40}\right)\text{ × 40\%}\right]$ = $8 million

Total projected tax liability = $\left(\text{\$6 + \$8}\right)$ = $14 million (5)

Note: Out of $60 million installment sale only $40 million qualify for deferred tax liability and $20 million belongs to “more likely than not” category. So, for calculating projected additional tax for installment sale we have to consider $20 million.

Step 3: Prepare journal entry at the end of 2016

Date	Account Title and Explanation	Post Ref.	Debit ($) (in millions)	Credit ($) (in millions)
2016	Income Tax Expense (6)		36
	Income Tax Payable (1)			6
	Deferred Tax Liability (4)			16
	Projected additional tax liability (5)			14
	(To record the income tax in 2016)

Table (5)

Working Notes:

Compute income tax expense amount.

$\begin{array}{c}\text{Income tax expense = }\left(\begin{array}{l}\text{Income }\\ \text{tax payable}\end{array}\right)\text{ + }\left(\begin{array}{l}\text{Deferred }\\ \text{tax liability}\end{array}\right)\text{ + }\left(\begin{array}{l}\text{Projected additional}\\ \text{tax}\text{liability}\end{array}\right)\\ \text{=}\left(\text{\$6}\text{+}\text{\$16+}\text{\$14}\right)\text{million}\\ \text{=}\text{\$36}\text{million}\end{array}$ (6)

Journal entry for the situations when the uncertainty about the tax position resolved:

Case 1: Interest income (Permanent difference)

In case of completely disallowed (Worst case):

Date	Account Title and Explanation	Post Ref.	Debit ($) (in millions)	Credit ($) (in millions)
2016	Projected additional tax for installment income (L -)		6
	Cash (A-)       Or Income Tax Payable (E +)			6
	(To record the tax liability in 2016)

Table (6)

In case of completely upheld (Best case):

Date	Account Title and Explanation	Post Ref.	Debit ($) (in millions)	Credit ($) (in millions)
2016	Projected additional tax for installment income (L-)		6
	Income Tax Expense (E+) (Benefit)			6
	(To record the tax liability in 2016)

Table (7)

Case 2: Interest income (Temporary difference)

In case of completely disallowed (Worst case):

Date	Account Title and Explanation	Post Ref.	Debit ($) (in millions)	Credit ($) (in millions)
2016	Projected additional tax for installment income (L -)		8
	Deferred tax liability (L-)		16
	Cash (A-)       Or Income Tax Payable (E +)			24
	(To record the tax liability in 2016)

Table (8)

In case of completely upheld (Best case):

Date	Account Title and Explanation	Post Ref.	Debit ($) (in millions)	Credit ($) (in millions)
2016	Projected additional tax for installment income (L-)		8
	Deferred tax liability (Setting additional deferred tax liability)			8
	(To record the tax liability in 2016)

Table (9)

When the uncertainty situation resolves, then cash (or income tax payable additional tax) becomes zero and closed to tax expense (permanent difference or to deferred tax (temporary difference).

Conclusion

This problem will provide the insights regarding the tax treatment for multiple difference and uncertain tax position along with necessary calculations like deferred tax liability, projected additional tax liability.