COMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATION

This Appendix presents a comprehensive illustration of a deffered income tax problem with several
temporary and permanent differences. The example follows one company through two complete years
(2010 and 2011). Study it carefully. It should help you understand the concepts and procedures presented
in the chapter.
FIRST YEAR2010
Allman Company, which began operations at the beginning of 2010, produces various products on a
contract basis. Each contract generaters an income of $80,000. Some of Allmans contracts provide for
the costumer to pay on an installment basis. Under these contracts Allman collects one-fifth of the
contract revenue in each of the following four years. For financial reporting purpose, the company
recognizes income in the year of completion (accrual basis); for tax purpose, Allman recognizes income
in the year cash is collected (installment basis).
Present below is information related to Allmans operations for 2010
1. In 2010, the company completed seven contracts that allow for the customer to pay on an
installment basis. Allman recognize the related income of $560,000 for financial reporting
purposes. It reported only $112,000 of income on installment sales on the 2010 tax return. The
company expects future collections on the related receivables to result in taxable amounts of
$112,000 in each of the next four years.
2. At the beginning of 2010, Allman Company purchased depreciable assets with a cost $540,000.
For financial reporting purpose, Allman depreciates these assets using yhe straigh-line method
over a six-years service life. The depreciation schedules for both financial reporting and tax
purposes are shown as:

Tahun
2010
2011
2012
2013
2014
2015

Depresiasi untuk tujuan

pelaporan keuangan
$90,000
90,000
90,000
90,000
90,000
90,000
$540,000

Depresiasi untuk
tujuan pajak
$108,000
172,800
103,680
62,208
62,208
31,104
$540,000

Perbedaan
$(18,000)
(82,000)
(13,680)
27,792
27,792
58,896
$-0-

3. The company warrants its product for two years from the date of completion of a contract. During
2010, the product warranty liability accrued for financial reporting purpose was $200,000 and the
amount paid for the satisfication of warranty liability was $44,000. Allman expects to settle the
remaining $156,000 by expenditures of $56,000 in 2011 and $100,000 in 2012.
4. In 2010, non-taxable governmental bond interest revenue was $28,000.
5. During 2010, non-deductible fines and penalties of $26,000 were paid.
6. Pretax financial income for 2010 amounts to $412,000
7. Tax rates enacted before the end of 2010 were:
2010

50%

2011

40%

8. The accounting period is the calendar year.

9. The company is expected to have taxable income in all future years.

Taxable Income and Income Tax Payable2010

The first step is to determine Allman Companys income tax payable for 2010 by calculating its taxable
income. Illustration A shows this computation.

Pretax financial income for 2010

Permanent differences:
Non-taxable revenuegovernment bond interest
Non-deductible expensesfines and penalties
Temporary differences:
Excess contract income per books ($560,000 - $112,000)
Excess depretiation per tax ($108,000 - $90,000)
Excess warranty expense per books ($200,000 - $44,000)
Taxable income for 2010

$412,000
(28,000)
26,000
(448,000)
(18,000)
156,000
$100,000

Allman computes income tax payable on taxable income for $100,000 as follows:

Taxable Income for 2010

Tax Rate
Income tax payable (current tax expense) for 2010

$100,000
x 50%
$50,000

COMPUTING Deferred Income TaxesEnd of 2010

The schedule in illustration B, summarizes the temporary differences and the resulting future taxable and
deductible amounts.

Future Taxable
(deductible) amounts:
Installment sales
Depreciation
Warranty costs

2011

2012

$112,00
0
(82,800)
(56,000)

$112,000
(13,680)
(100,000

Future Years
2013
$112,00
0
27,792

2014
$112,00
0
27,792

2015

Total
$448,000

$58,896

18,000
(156,000

Allman computes the amounts of deffered income taxes to be reported at the end of 2010 as shown in
Ilustration C:

Temporary Differences
Installment Sales
Depreciation
Warranty Cost
Totals

Future
Taxable
(Deductible)
Amounts
$448,000
18,000
(156,000)
$310,000

Tax
Rate
40%
40%
40%

Defferd Tax
(Asset)
(Liability
)
$179,200
7,200
$(62,400
)
$(62,400
$186,400*
)

*Because only a single tax rate is involved in all relevant years, these totals can be reconciled $310,000 x 40% = ($62,400) +
$186,400

A temporary difference is caused by the use of the accrual basis for financial reporting purpose and the
installment method for tax purposes. The temporary difference will result in future taxable amounts, and
hence, a deffered tax liability. Because of the installment contracts completed in 2010, a temporary
difference of $448,000 originates that will reverse in equal amounts over the next four years. The
company expects to have taxable income in all future years, and there is only one enacted tax rate
applicable to all future years. Allman uses that rate (40 percent) to compute the entire deffered tax liability
resulting from this temporary difference.
The temporary difference caused by different depreciaton polices for books and for tax purpose originates
over three years and then reverse over three years. This difference will cause deductible amounts in 2011
and 2012 and taxable amounts in 2013, 2014, and 2015. These amounts sum to a net future taxable
amount of $18,000 (which is the cumulative temporary difference at the end of 2010). Because the
company expects to have taxable income in all future years and because there is only one tac rate enacted
for all of the relevant future years, Allman applies that rate to the net future taxable amount to determine
the related net deffered tax liability.
The third temporary difference is caused by different methods of accountingfor warranties. This
difference will result in deductible amounts in each of the two future years it takes to reverse. Because the
company expects to report a positive income on all future tax returns and because there is only one tax
rate enacted for each of the relevant future years, Allman uses that 40 percent rate to calculate the
resulting deffered tax asset.
Defereed Tax Expense (Benefit) and the Journal Entry to Record Income Taxes2010
To determine the deffered tax expense (benefit), we need to compare the beginning and ending balances
of the deffered income tax accounts. Illustration D shows that computation:

Deffered tax asset at the end of 2010

Deffered tax asset at the beginning of 2010
Deffered tax expanse (benefit)
Deffered tax liability at the end of 2010
Deffered tax liability at the beginning of 2010
Deffered tax expense (benefit)

$62,400
-0$(62,400)
$186,400
-0$186,400

The $62,400 increase in the deffered tax asset causes a deffered tax benefit to be reported in the income
statement. The $186,400 increase in the deffered tax liability during 2010 result in a deffered tax expense.
These two amounts net to a deffered tax expense of $124,000 for 2010.
Deffered tax expense (benefit)
Deffered tax expense (benefit)
Net differed tax expense for 2010

$(62,400)
186,400
$124,000

Allman records income tax payable, deffered income taxes, and income tax expense as follows:
Current tax expense for 2010
Deffered tax expense for 2010
Income tax (total) for 2010

$50,000
124,000
$174,000

Allman record income tax payable, deffered income taxes and income tax expense as follows.
Income Tax Expense
Deffered Tax Asset

174,000
62,400

Income Tax Payable

50,000

Deffered Tax Liablity

186,400

Financial Statement Presentation2010

Companies should classify deffered tax assets and liabilities as non-current on the statement of financial
position. Deffered tax assets are therefore netted against deffered tax liabilities to compute a net Deffered

asset (liability). Ilustrations E shows the calsification of Allmans deffered tax accounts at the end of
2010.

Temporary Difference
Installment Sales
Depreciation
Warranty Cost
Totals

Resulting Deffered Tax

(Asset)
(Liabilty)
$179,200
7,200
$(62,000)
(62,000)
$186,400

The statement of financial position at the end of 2010 reports the following amounts.
Non-Current Liabilies
Deffered tax liability ($186,400 - $62,400)

$124,000

Current Liabilities
Income tax payable

$50,000

Allmans income statement for 2010 reports the following:

Income Before income taxes
Income Tax Expense
Current
Deffered
Net Income

$412,000
$50,000
124,000

174,000
$238,000

Second Year2011
1. During 2011, Allman collected $112,000 from customers for the receivavles arising from
contracts completed in 2010. The company expects recovery of the remaining receivables to
result in taxable amounts of $112,000 in each of the following three years.
2. In 2011, the company completed four new contracts that allow for the customer to pay on an
installment basis. These installment sales created new installment receivables. Future collections

of these receivables will result in reporting income of $64,000 for tax purpose in each of the next
four years.
3. During 2011, Allman continued to depreciate the assets acquired in 2010 according to the
depreciation schedules appearing before. Thus, depreciation amounted to $90,000 for financial
reporting purposes and $172,800 for tax purposes.
4. An analysis at the end of 2011 of the product warranty liability account showed the following
details.

Expense for 2011 income statement purposes

Amount paid for contracts completed in 2010
Amount paid for contracts completed in 2011
Balance liability at end of 2011

$156,000
180,000
(56,000)
(50,000)
$230,000

At the balance of the liability is expected to require expenditures in the future as follows:
$100,000 in 2012 due to 2010 contracts
$ 50,000 in 2012 due to 2011 contracts
$ 80,000 in 2013 due to 2011 contracts
$230,000
5. During 2011, non-taxable governmental bond interest revenue was $24,000
6. Allman accrued a loss of $172,000 for financial reporting purpose because of pending litigation.
This amount is not tax-deductible unti the period the loss is realized which the company estimates
to be 2019.
7. Pretax financial income for 201 amounts to $504,800.
8. The enacted tax rates still in effect are:
2010 50%
2011 40%
Taxable Income and Income Tax Payable2011
Allman computes taxable income for 2011 as follows.

Pretax financial income for 2011

Permanent differences:
Non-taxable revenuegovernment bond interest
Reversing temporary differences:
Collections on 2010 installment sales
Payments on warranties from 2010 contracts
Originating temporary differences:
Excess contract income per books2011 contracts
Excess depreciation per tax
Excess warranty expense per books2011 contracts

$504,800
(24,000)
112,000
(56,000)
(256,000)
(82,800)
130,000

Loss accrual per books

Taxable income for 2011

172,000
$500.000

Income tax payable for 2011 is as follows:

Taxable Income for 2011

Tax Rate
Income tax payable (current tax expense) for 2011

$500,000
x 40%
$200,000

Computing Deffered Income TaxesEnd of 2011

The schedule in illustration before, summarizes the temporary differences existing at the end of 2011 and
the resulting future taxable and deductible amounts.

Future Taxable
(deductible) amounts:
Installment sales2010
Installment sales2011
Depreciation
Warranty costs
Loss Accrual

2012

2013

$112,000
64,000

$112,000
64,000

(13,680)
(150,000
)

27,792
(80,000)

Future Years
2014
$112,00
0
64,000
27,792

2015

2019

Total
$336,000
256,000

64,000
58,896
$(172,000
)

100,800
(230,000
)
(172,000
)

Allman computes the amounts of deffered income taxes to be reported at the end of 2011 as follows:

Temporary Differences
Installment Sales
Depreciation
Warranty Cost
Loss Accrual

Future
Taxable
(Deductible)
Amounts
$592,000*
100,800
(230,000)
(172,000)

Tax
Rate
40%
40%
40%
40%

Defferd Tax
(Asset)
(Liability)
$236,800
40,320
$(92,000)
$(68,800)

Totals

$290,800

$(160,800)

$277,120**

*Cumulative temporary differences = $336,000 + $256,000

**Because of a flat tax rate, these totals can be reconciled: $290,800 x 40% = $(160,800) + $277,120

Deffered Tax Expense (Benefit) and the Journal Entry to record Income Taxes2011
To determine the deffered tax expenses (benefit), Allman must compare the beginning and ending
balances of the deffered income tax accounts, as shown in Illustration:

Deffered tax asset at the end of 2011

Deffered tax asset at the beginning of 2011
Deffered tax expanse (benefit)
Deffered tax liability at the end of 2011
Deffered tax liability at the beginning of 2011
Deffered tax expense (benefit)

$160,800
62,400
$(98,400)
$277,120
186,400
$90,720

The deffered tax expense (benefit) and the total income tax expense for 2011 are, therefore, as follows:
Deffered tax expense (benefit)
Deffered tax expense (benefit)
Deffered tax expense for 2011

$(98,400)
90,720
(7,680)
200,000
$192,320

Current tax expense for 2011

Income tax expense (total) for 2011

The deffered tax expense of $90,720 and the deffered expense of $90,720 and the deffered tax benefit of
$98,400 net to a deffered tax benefit of $7,680 for 2011.
Allman records income taxes for 2011 with the following journal entry:
Income Tax Expense
Deffered Tax Asset

192,320
98,400

Income Tax Payable

200,000

Deffered Tax Liablity

90,720

Financial Statement Presentation2011

Shows the classification of Allmans deffered tax accounts at the end of 2011

Temporary Difference
Installment Sales
Depreciation
Warranty Cost
Loss Accrual
Totals

Resulting Deffered Tax

(Asset)
(Liabilty)
$236,800
40,320
$(92,000)
(68,800)
$(160,800)
$277,120

Allmans statement of financial position at the end of 2011 reports the following amounts.
Non-Current Liabilies
Deffered tax liability ($277,120 - $160,800)

$116,320

Current Liabilities
Income tax payable

$200,000

The income statement for 2011 reports the following.

Income before income taxes
Income tax expense
Current
Deffered
Net Income

$504,800
$200,000
(7,680)

192,320
$312,480