Question

Frigga Industries, which faces a marginal tax rate of 40%, reported the following book-tax differences for

the year underlying accounts of its balance sheet:

12/31/16

12/31/17

12/31/18

Carrying value of fixed

assets – book basis

$2,200,000

$1,800,000

$1,400,000

Carrying value of fixed

assets – tax basis

$2,200,000

$1,500,000

$1,300,000

In addition, Frigga recorded a loss contingency in 2016 for $3,000,000 that will not be tax deductible

until 2018 when the settlement is expected to be paid in cash.

Frigga also has the following expenses and tax deductions related to prepaid expenses for the years 2017

and 2018:

2017

2018

Expenses incurred from prepaid

expenses per income statement

(accruals)

$1,200,000

$1,300,000

Tax deductible expenses from

prepaid expenses (cash

payments)

$800,000

$1,600,000

Pretax book income for Frigga was $5,000,000 in 2017 and $6,000,000 in 2018.

1. Classify each book-tax difference as a DTA or DTL.

2. Provide a reconciliation of book income to taxable income for 2017 and 2018.

3. Provide journal entries to record tax expense and the changes in the DTA and DTL accounts for

2017 and 2018.

4. If Frigga had initiated an incentive stock option program (non tax deductible), recording

compensation expense of $300,000 in 2017 and $200,000 in 2018, how would this affect the

journal entries you recorded in #3?

Answer 1

2016	Book	Tax	Difference	Analysis	Tax rate	DTA	DTL
Carrying value of asset	2,200,000	2,200,000	-
Contingency loss	3,000,000	-	3,000,000	Expenses in book is more and tax expense is less, DTA	40%	1,200,000
Prepaid expenses
Closing DTA of 2016						1,200,000

2,017	Book	Tax	Difference	Analysis	Tax rate	DTA	DTL
Carrying value of asset	1,800,000	1,500,000	300,000	Book carrying value is more, hence book expense is less, tax expense is more, DTL	40%		120,000
Contingency loss			-	Expenses in book is more and tax expense is less, DTA	40%	-
Prepaid expenses	1,200,000	800,000	400,000	Expenses in book is more and tax expense is less, DTA	40%	160,000
				Net DTA		40,000
				DTA of 2016		1,200,000

2018	Book	Tax	Difference	Analysis	Tax rate	DTA	DTL
Carrying value of asset	1,400,000	1,300,000	100,000	Book carrying value is more, hence book expense is less, tax expense is more, DTL	40%		40,000
Contingency loss	-	3,000,000	-3,000,000	Expenses in book is less and tax expense is more, DTL	40%		1,200,000
Prepaid expenses	1,300,000	1,600,000	-   300,000	Expenses in book is less and tax expense is more, DTL	40%		120,000
							1,360,000
				DTA of 2017			40,000

Reconciliation of book and tax income		2017	2018
Book income		5,000,000	6000000
Depreciation as per books	Add	400,000	400,000
Loss contingency as per tax	Deduct	0	3,000,000
Depreciation as per tax	Deduct	700,000	200,000
Prepaid in books	add	1,200,000	1,300,000
Prepaid as per tax	Deduct	800,000	1,600,000
Taxable income		5,100,000	2,900,000
Tax rate	40%	40%	40%
Tax amount		2,040,000	1,160,000

Account	Dr/Cr	Amount (DR)	Amount (CR)	Narration
2017
Tax expense	Dr	1,160,000		For recognition of DTA of 2017
DTA	Cr		1,160,000	For recognition of DTA of 2017
Tax expense	Dr	2,040,000		For income tax expense for 2017
Provision for income tax	Cr		2,040,000	For income tax expense for 2017
2018
Tax expense	Dr	40,000		For derecognition of DTA of 2017
Tax expense	Dr	1,360,000		For recognition of DTL of 2017
DTL	cr		1,400,000	For recognition of DTL of 2017
Tax expense	Dr	1,160,000		For income tax expense for 2018
Provision for income tax	Cr		1,160,000	For income tax expense for 2018

Tax expense - considering the stock compensation expense		2017	2018
Book income		5,000,000	6000000
Depreciation as per books	Add	400,000	400,000
Loss contingency as per tax	Deduct	0	3,000,000
Depreciation as per tax	Deduct	700,000	200,000
Prepaid in books	add	1,200,000	1,300,000
Prepaid as per tax	Deduct	800,000	1,600,000
Non tax deductible- stock compensation expenses	Add	300,000	200,000
Taxable income		5,400,000	3,100,000
Tax rate	40%	40%	40%
Tax amount		2,160,000	1,240,000

Journal entry for the tax expense will undergo a change based on above workings

		2,017	2018
Tax expense	Dr	2,160,000	1,240,000
Provison for income tax	Cr	2,160,000	1,240,000

This expense being non tax deductible, ever, assuming the same as a permanent difference, no effect on DTA/DTL recognised

Hence the DTA and DTL recongnised for years 2017 and 2018 the Journal entries would remain the same