Financial Accounting: Liabilities & Equities (FA3) Exam Review

FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Question 4 (13 marks)
Lion Ltd. is about to prepare its financial statements for the year ended December 31,
2004. Pertinent information follows:
• In 2004, amortization was $270,000 and CCA was $135,000. At the beginning
of the year, the net book value of capital assets was $2,000,000, while the UCC
was $1,500,000.
• Accounting income before income taxes was $1,000,000.
• The company had $50,000 in entertainment expenses, which were included in
the income statement. Only 50% of this amount is deductible for tax purposes.
• The company received rent in advance of $75,000. This amount is taxable but
has not been included in its income statement.
• In March 2004, the income tax rate for 2004 and later years increased to 35%.
This was not expected since the income tax rate had been 30% since 2000. The intended
change was enacted into law in November 2004.
Required
11 a. Assume that Lion is a public company. Reconcile ―Accounting income before
income taxes‖ to ―Taxable income,‖ and prepare the required income tax related journal
entries for 2004.
2 b. Prepare the bottom section of the income statement, beginning with income before
income taxes.
11 a. Income taxes payable
(1/2) Accounting income before income taxes $ 1,000,000
Permanent differences
(1/2) 50% entertainment expenses 25,000
Temporary differences
(1/2) Rent received in advance 75,000
(1/2) CCA (135,000)
(1/2) Amortization/depreciation 270,000
(1/2) Taxable income $ 1,235,000
Income tax payable @ 35% $ 432,250
Journal entry:
(2) Income tax expense (432,250 – 26,250 – 22,250) ....................... 383,750
(2) Deferred/Future income tax asset - rent revenue ......................... 26,250
(2) Deferred/Future income tax liability - capital assets ... 22,250
(2) Income taxes payable....................................................................... 432,250
2 b. Income statement
(1/2) Income before income taxes $ 1,000,000
(1/2) Income tax expense — current $ 432,250
(1/2) — Deferred/future (48,500) 383,750
(1/2) Net income $ 616,250
Effective tax rate: 383,750/1,000,000 = 38.375%
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