Davidson Gasket Inc. computed a pretax financial loss of $25,000 for the first year of its operations, ended December 31, 2013. Analysis of the tax and book bases of its liabilities disclosed $55,000 in unearned rent revenue on the books that had been recognized as taxable income in 2013 when the cash was received. Also disclosed was $20,000 in warranties payable that had been recognized as expense on the books in 2013 when product sales were made but that are not deductible on the tax return until paid.
These temporary differences are expected to reverse in the following pattern.
Year ___________________Rent Earned on Books __________Warranty Payments
2014 . . . . . . . . . . . . . . . . . . . . . . . . $13,000 .................................... $ 5,000
2015 . . . . . . . . . . . . . . . . . . . . . . . . . 25,000 ...................................... 8,000
2016 . . . . . . . . . . . . . . . . . . . . . . . . . 12,000 ...................................... 7,000
2017 . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000
Totals . . . . . . . . . . . . . . . . . . . . . . . $55,000 .................................... $20,000
The enacted tax rates for this year and the next four years are as follows:
2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38%
2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Instructions:
1. Prepare journal entries to record income taxes payable and deferred income taxes. Assume there will be sufficient income in each future year to realize any deductible amount.
2. Prepare the income statement for Davidson Gasket Inc. beginning with Loss from continuing operations before income taxes for the year ended December 31, 2013.
3. If future taxable income from operations was not expected to be sufficient to allow for the full realization of any deferred tax assets, what other sources of income may be used to avoid establishing a valuation allowance?