You Are The New Controller For Go Corporation This Is Go's F
You Are The New Controller For Go Corporation This Is Gos First Yea
You are the new controller for GO CORPORATION. This is GO’s first year of operations and everything went much better than anyone anticipated. It went so well, that your pre-tax profits for the year were $5,000,000. Unfortunately, no one bothered to pay any income taxes (federal or state) for the whole year because they were all so busy growing the business and never thought they were making a GAAP profit. The CFO has put you in charge of calculating and accounting for all of the income tax balances, including the balance sheet and income statement amounts.
Not knowing where to start, you began by looking at the trial balance (post-adjusting entries with the exception of the tax entries). You found, as suspected, that there are no income tax accounts on the trial balance, which means you have to create them all somehow by tomorrow afternoon. After a bit of reflection and a review of the trial balance, you have found the following information which you think, but are not sure, is relevant. You then call your sister who happens to be a CPA for help. After agreeing on a fee of $900/hour, she agrees to come help you that evening.
TRIAL BALANCE INFORMATION DR/(CR) Accounts receivable 2,000,000 AFDA (300,000) Accrued Vacation (200,000) Deferred revenue (1,000,000) Fixed Assets 3,000,000 Accum Depr (150,000) Officer life insurance Expense 100,000 Meals & Entertainment Expense 500,000 Your sister tells you that for tax purposes, the governments (both federal and state to make it easy) require you to use the Modified Accelerated Cost Recovery System (MACRS) for tax depreciation purposes (whatever that is). You google it and find out that the type of fixed assets you own require you to use the double declining balance method, ½ year convention, and 5 year life. The federal tax rate (we are ignoring completely the graduated rate brackets for simplicity) is 35% and since you only do business in California, the state rate is 8.84% on your taxable income.
Your sister also tells you that your state taxes are currently deductible on your federal tax return (can this get any harder?). a. Calculate and prepare journal entries to record your current taxes payable (separately show federal and state) and your current income tax expense or benefit. b. Calculate and prepare journal entries to record your deferred tax asset and/or liabilities and deferred tax expense or benefit. c. State your net total tax expense or benefit and calculate the effective tax rate on your pre-tax income.
Paper For Above instruction
Introduction
The inception of GO CORPORATION's first fiscal year presented unique challenges and opportunities in accounting for income taxes. As a newly established entity with no prior tax records, the corporation's financial statements require the accurate recording of current and deferred taxes based on its pre-tax profit of $5,000,000. This paper discusses the process of estimating income tax liabilities, identifying temporary and permanent differences, and preparing journal entries to reflect both current tax payable and deferred tax assets or liabilities, culminating in the calculation of the effective tax rate.
Understanding the Tax Environment
GO CORPORATION’s operations are subject to federal and California state income taxes. The federal corporate tax rate is 35%, and the California state rate is 8.84%. Notably, state taxes are deductible for federal purposes, affecting the calculation of taxable income and resulting in specific deferred tax considerations. The application of the Modified Accelerated Cost Recovery System (MACRS) for depreciation, particularly the double declining balance method with half-year convention over a five-year life, impacts taxable income and deferred tax calculations.
Current Tax Calculations
The first step involves calculating the current income tax payable separately for federal and state governments based on the pre-tax income of $5 million (assuming no permanent differences).
Federal taxes:
Taxable income = $5,000,000
Federal tax rate = 35%
Federal tax payable = $5,000,000 × 35% = $1,750,000
State taxes:
State tax rate = 8.84%
State tax payable = $5,000,000 × 8.84% = $442,000
Since state taxes are deductible in federal calculations, the federal tax payable would be adjusted for this deduction, impacting the current tax expense.
These calculations require journal entries:
```plaintext
Dr. Income Tax Expense – Federal 1,750,000
Cr. Federal Income Taxes Payable 1,750,000
Dr. Income Tax Expense – State 442,000
Cr. State Income Taxes Payable 442,000
```
Adjustment for deductibility of state taxes:
The federal income tax expense should be adjusted to account for the deductibility of state taxes, effectively reducing the federal tax liability to approximately $1,750,000 - (8.84% of $5 million).
Calculating this:
State tax deduction in federal = $442,000
Federal tax savings = $442,000 × 35% = $154,700
Adjusted federal tax expense = $1,750,000 - $154,700 = $1,595,300
Final journal entries for current taxes:
```plaintext
Dr. Income Tax Expense – Federal 1,595,300
Cr. Federal Income Taxes Payable 1,595,300
Dr. Income Tax Expense – State 442,000
Cr. State Income Taxes Payable 442,000
```
Total current tax expense:
Federal: $1,595,300
State: $442,000
Total: $2,037,300
Deferred Tax Assets and Liabilities
The differences between GAAP and tax accounting create temporary differences, primarily due to depreciation, accrued vacations, deferred revenue, and life insurance expenses.
Depreciation:
GAAP uses straight-line depreciation with an $150,000 accumulated depreciation. For tax purposes, MACRS with double declining balance, half-year convention, and five-year life is used. The initial depreciation under MACRS is accelerated, resulting in a lower taxable income in the immediate years, which creates a deferred tax liability that will reverse over time.
Calculating MACRS depreciation for the first year:
- Asset cost = $3,000,000
- Recovery period = 5 years
- Double declining balance rate = 2 × 100% / 5 = 40%
- Year 1 depreciation base = $3,000,000
- MACRS depreciation for Year 1 = $3,000,000 × 40% × 0.5 (half-year convention) = $600,000
This accelerated depreciation is tax-deductible now, reducing taxable income by an additional $600,000 for tax purposes compared to GAAP, creating a deferred tax liability:
Deferred tax liability = $600,000 × 35% = $210,000
Other temporary differences:
- Accrued vacation:
GAAP expense is $200,000, but for tax, accrued vacation may not be deductible until paid, creating a deferred tax asset:
Deferred tax asset = $200,000 × 35% = $70,000
- Deferred revenue:
The $1,000,000 of deferred revenue is recognized as income under GAAP but may not be taxable until received, creating a deferred tax liability:
Deferred tax liability = $1,000,000 × 35% = $350,000
- Officer life insurance expense:
Life insurance premiums paid on officers' life are typically not deductible for tax purposes, creating a temporary difference that results in a deferred tax asset:
Deferred tax asset = $100,000 × 35% = $35,000
Net deferred tax position:
Total deferred tax assets = $70,000 + $35,000 = $105,000
Total deferred tax liabilities = $210,000 + $350,000 = $560,000
Net deferred tax = $560,000 - $105,000 = $455,000 deferred tax liability
Journal entries for deferred taxes:
```plaintext
Dr. Deferred Tax Asset 105,000
Cr. Deferred Tax Liability 455,000
Cr. Income Tax Expense – Deferred 350,000
```
(The actual entries depend on initial recognition; here, the net liability is recognized for simplicity.)
Tax Expense and Effective Tax Rate
The total income tax expense combines current and deferred components:
- Current tax expense (Federal + State): $2,037,300
- Deferred tax expense (net): $350,000 (liability increase)
Total tax expense = $2,387,300
Net income and effective tax rate:
Pre-tax income = $5,000,000
Tax expense = $2,387,300
Effective tax rate = ($2,387,300 / $5,000,000) × 100% ≈ 47.75%
This effective tax rate exceeds the statutory rates owing to temporary differences and nondeductible expenses. The substantial deferred tax liability and current taxes illustrate the impact of accelerated depreciation and other timing differences.
Conclusion
The first-year tax accounting for GO CORPORATION involves complex calculations integrating current and deferred taxes resulting from temporary differences between GAAP and tax bases of assets and liabilities. Proper recording ensures compliance with GAAP and tax laws, providing an accurate picture of the company's fiscal position. The overlapping of federal and state tax effects, particularly through deductibility of state taxes and depreciation methods, emphasizes the importance of understanding both jurisdictions' tax laws for accurate financial reporting. Accurate tax provision recording not only meets compliance standards but also informs strategic decision-making for future tax planning.
References
- Alexander, D., & Nobes, C. (2019). Financial Accounting: An International Introduction. Pearson Education.
- Berry, A., & Fredette, B. (2017). Corporate Taxation Under the Tax Cuts and Jobs Act. Journal of Accounting, Ethics & Public Policy, 18(2), 257-277.
- Gittings, A. (2018). Tax Accounting: Principles and Practice. Routledge Publishing.
- Price, R., & Weirich, T. (2020). Advanced Corporate Taxation. McGraw-Hill Education.
- Internal Revenue Service. (2023). Publication 946: How to Depreciate Property. IRS.gov.
- California Franchise Tax Board. (2023). California Corporate Income Tax Law. FTB.ca.gov.
- Schmidt, M. (2019). Deferred Tax Assets and Liabilities. CPA Journal, 89(4), 42–47.
- Wahlen, F., & Baginski, S. (2019). Financial Reporting, Financial Statement Analysis, and Valuation. Cengage Learning.
- IRS. (2022). Instructions for Form 1120. Internal Revenue Service.
- Thompson, R. (2021). Effective Strategies for Tax Planning and Compliance. Tax Analysts Publications.