Question

Leer Corp.'s pre-tax income in 20X5 is $100,000. The temporary differences between amounts reported in the financial statements and the tax return are as follows:

• Depreciation in the financial statements is $8,000 more than tax depreciation.
• The equity method of accounting resulted in financial statement income of $35,000. A $25,000 dividend is received during the year, which is eligible for the 80% dividends received deduction.

Leer's effective income tax rate was 30% in 20X5. In its 20X5 income statement, Leer should report a current provision for income taxes of

	$26,400
	$23,400
	$21,900
	$18,600

This Answer is Correct (Answer is B, $23,400)

The current provision for income taxes is the tax liability for the year: taxable income times the tax rate. Taxable income = $100,000 + $8,000 − $35,000 + .20($25,000) = $78,000. Therefore, current income tax expense (also the firm's tax liability) is $23,400 ($78,000 × .30).

The $8,000 is added to pre-tax accounting income, because the latter income amount reflects $8,000 more depreciation than should be reflected in taxable income. The $35,000 is subtracted, because it is included in pre-tax accounting income, but is not included in taxable income. Only 20% of the dividends received is taxable owing to the 80% dividends-received deduction. The equity in income of the investee is not taxable income.

Can please explain in good details and an a easy way why the depreciation in financial statements of $8,000 is added to taxable income and why the $35,000 of income from the equity method is subtracted from taxable income regardless of explanation above because I don't understand it?

Answer 1

i will explain this in two parts

in income tax provisions , there are certain expenses and income which are not regarded for income tax purpose

due to this concept the earning due to euity method of accounting will not be considered as income while calculating , therefore we need to deduct that amount from net income to calculate income tax

also income tax provision lay down various criteria for depreciation based on class of assets , due to this there is difference in depreciation in income tax and depreciation in accounting.

for calculating income tax we need to adhere to income tax provisons for calculations of depreciation , therefore we are adding $8000 from net income here to calculate net income as per income tax law.