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

Answer 1

Ajax Company began operations on January 1, 2020

	2020	2021	2022
Pretax income	100000	100000	100000
Add: Future deductible	100000 (Deferred tax assets)	-50000 (reversal)	-50000 (reversal)
Taxable income	200000	50000	50000

On 2020,

Debit to deferred tax assets = 100000 * 35% = $35000

Journal entry on 2020

Date	Accounts	Debit	Credit
2020	Income tax expenses (100000*35%)	$35000
	Deferred tax Assets (100000*35%)	$35000
	Income tax payable (200000*35%)		$70000
	(To record income tax expenses)

On 2021,

Income tax expenses according to GAAP = 100000* 35% = 35000

Income tax payable according to tax code = 50000 * 35% = 17500

Adjustment

Income Journal entry on 2021

Date	Accounts	Debit	Credit
2021	Income tax expenses (100000*35%)	$35000
	Deferred tax Assets		$17500
	Income tax payable (50000*35%)		$17500
	(To record income tax expenses)

Correct answer: -

Ajax’s income tax adjusting entry for 2021?

Credit to Deferred Tax Asset of $17,500