Aaron Engines Ltd. operates small engine repair outlets and is a tenant in several of Tran Holdings Inc.'s strip shopping malls. Aaron signed several lease renewals with Tran that each called for a three-month rent-free period. The leases start at various dates and are for three to five years each. As with all of Tran's tenants, Aaron pays rent quarterly, three months in advance, and records the payments initially to Prepaid Rent.
The rent-free period obtained in the lease agreement with Tran Holdings Inc. reduces the overall rental costs of the outlets over the term of each lease. Aaron's accounting policy requires the leasing costs of each outlet to be allocated evenly over the term of the lease to fairly match expenses with revenues. Aaron accrues rent expense during the rent free period to an account called Rent Payable. Following the rent-free period, the Rent Payable account is amortized to Rent Expense over the remaining term of the lease. For tax purposes, Aaron must use the cash basis and is unable to deduct the rent expense accrued during the rent-free periods. On its tax return, Aaron can only deduct the actual rent payments when they are made.
The balances for the accounts related to prepaid rent and rent payable under leases as well as payments for interest to earn tax-exempt income and payments for golf club dues for the years ending December 31, 2015 and 2014, follow:
2015 2014
Prepaid Rent (assume current classification and no balance
at Dec. 31, 2013)..................................................................$ 92,000.........$ 89,000
Rent Payable (assume non-current classification and no balance
at Dec. 31, 2013)...................................................................133,000..........146,000
Golf Dues Expense..................................................................11,000...........13,000
Interest Expense (incurred to earn tax-exempt income)..........................6,000............4,000
In 2014, Aaron's tax rate is 28%, and for subsequent years it is 27%. Income before income tax for the year ended December 31, 2014, was $884,000. During 2015, Aaron's tax rate changed to 29% for 2015 and subsequent years. Income before income tax for the year ended December 31, 2015, was $997,000. Assume that Aaron Engines Ltd. applies ASPE.
Instructions
(a) Calculate the deferred tax asset or liability balances at December 31, 2014, and 2015.
(b) Calculate taxable income and income tax payable for 2014 and 2015.
(c) Prepare the journal entries to record income taxes for 2014 and 2015.
(d) Prepare a comparative income statement for 2014 and 2015, beginning with the line "Income before income tax."
(e) Provide the comparative balance sheet presentation for any resulting deferred tax accounts at December 31, 2014, and 2015. Be specific about the classification.
(f) Calculate the effective rate of tax for 2015. Provide a reconciliation and explanation of why this differs from the statutory rate of 29%. Begin the reconciliation with the statutory rate.
(g) How would your responses to parts (a) to (f) change if Aaron applied IFRS instead of ASPE?