Question

Ajax Company began operations on January 1, 2020. One service Ajax provides is financial services to individual investors using binding three year contracts payable in advance. US GAAP requires that the revenue collected in the first year be recognized as it is earned over the three-year contract term. The tax code recognizes the full contract revenue in year 1.   Ajax expects pretax accounting income of $125,000 each year. Under US GAAP reporting, Ajax expects to record revenue of $100,000 each year for the next three years (2020, 2021, and 2022). Under Tax Code reporting, Ajax expects taxable revenue of $200,000 in 2020, and $50,000 in each of 2021 and 2022. The tax rate in 2020 is 35%; this rate is expected to stay constant through 2022. Which of the following would be part of Ajax’s income tax adjusting entry for 2021?

Question 5 options:

	Credit to Deferred Tax Asset of $17,500.
	Credit to Deferred Tax Liability of $35,000.
	Debit to Deferred Tax Liability of $17,500.
	Debit to Deferred Tax Asset of $35,000.

Answer 1

Taxable revenue is of $200,000 in 2020. Hence, tax will be 35%. It is equal to $70,000 (200,000×35%).

Accounting Income according to books is at $100,000. Tax rate is at 35%,which is equal to $35,000 (100,000×35%).

If the income as per books is less than taxable income then it means we have to paid more tax and has to pay less tax in future. Hence, it will be a Deferred Tax Asset with the balance amount. Hence, answer to the question is Debit to Deferred Tax Asset of $35,000 ($70,000-$35,000).