Flynn Inc. has two temporary differences at the end of 20X2. The first difference stems from installment sales, and the second one results from the accrual of a loss contingency. Flynns accounting department has developed a schedule of future taxable and deductible amounts related to these temporary differences as follows.

	20X3	20X4	20X5	20X6
Taxable Amounts	$ 40,000	$ 50,000	$60,000	$90,000
Deductible Amounts		(15,000)	(19,000)
	$40,000	$35,000	$41,000	$90,000

As of the beginning of 20X2, the enacted tax rate is 34% for 20X2 and 38% for 20X3-20X7. At the beginning of 20X2, the company had no deferred income taxes on its balance sheet. GAAP pre-tax income and taxable income for 20X2 is $400,000. Taxable income is expected in all future years. GAAP pretax income for 20X3 is $10,000. In addition, in 20X3, the company paid fines/penalties of $3,000 for late filing of its payroll taxes.

Required:

(a) Prepare journal entries to record income taxes for 20X2 and 20X3. Assume in 20X2, management believed the company would benefit from the loss contingency; in 20X3, management believes that the loss contingency probably will not occur and the company wont benefit.

(b) Prepare the balance sheet disclosure pertaining to the deferred taxes. Assume the related asset and liabilities that caused the temporary differences are classified as noncurrent items on the balance sheet.

(c) Prepare the income statement for 20X2 and 20X3, beginning with Income before income taxes.