[Anonymous]

White Industries started their operations on January 1, Year 1 and recorded $400,000 in warranty expense during the year. Warranty expense was the only difference between the company’s pretax financial income and its tax return income of $900,000. White will be required to pay these warranties at a rate of $100,000 per year beginning in Year 2. Although White fully expects to earn in excess of $100,000 in Year 2 and Year 3, the company believes it is more likely than not that it will incur a loss after Year 3. The enacted tax rate is 25% in current and future periods. What will White record as its income tax expense in Year 1?

a. $175,000

b. $100,000

c. $225,000

d. $125,000

The correct answer is A.

The journal entry I made are:

DR Income tax expense: $225,000

DR DTA: $100,000

CR Valuation allowance $50,000

CR Income tax benefit-deferred $50,000

CR Income taxes payable $225,000

Becker simplified the entries to

DR Income tax expense: $175,000

DR DTA: $100,000

CR Valuation allowance $50,000

CR Income taxes payable $225,000

So, the current tax expense of $225,000 is offset with the $50,000 income tax benefit deferred to obtain a total provision of income taxes of $175,000. (We can debit the income tax benefit and credit the income tax expense by 50.) Now keep this fact in mind as we analyze the second question with a NOL.

Mobe Co. reported the following operating income (loss) for its first three years of operations:

Year 1 $ 300,000

Year 2 (700,000)

Year 3 1,200,000

For each year, there were no deferred income taxes (before Year 1), and Mobe’s effective income tax rate was 30%. In its Year 2 income tax return, Mobe elected the two year carry back of the loss. In its Year 3 income statement, what amount should Mobe report as total income tax expense?

a. $120,000

b. $360,000

c. $150,000

d. $240,000

The correct answer is “b.” Becker’s JEs for year 2 is:

DR: Income taxes receivable $90,000

DR: Deferred tax assets $120,000

CR: Income Tax Benefit $210,000

Becker JEs for year 3 is:

DR: Income Tax Expense $360,000

CR: Income Taxes Payable $240,000

CR: Deferred Tax Assets $120,000

Ok, here is my question. When we reversed the DTA, technically we still have $210,000 of Income Tax Benefit on the books. Given these JEs shouldn’t the total income tax expense be $360,000 – $210,000 = $150,000? Conceptually, I understand why “B” is correct. (The DTA is no longer there.) However, what is the correct way of making sense of the answer through correct JEs?

Thanks!!