Given: THE BASIC ILLUSTRATION

To illustrate, NOVA Corporation acquired depreciable equipment with a useful life of 5 years for $360,000. NOVA established a zero salvage value, uses straight line depreciation for book purposes (i.e., for their F/S), and uses accelerated depreciation for tax purposes (i.e., for their T/R). Tax Rate = 33%

Table #1 Tax Return Versus Book Depreciation Expense

	20X1	20X2	20X3	20X4	20X5
Accelerated Depreciation	116,667	93,345	70,000	46,673	33,315
Straight Line Depreciation	72,000	72,000	72,000	72,000	72,000
Difference	<44,667>	<21,345>	2,000	25,327	38,685

Table #2 Tax Return B/S Values

	20X1	20X2	20X3	20X4	20X5
Net Book Value beginning	360,000	243,333	149,988	79,988	33,315
Depreciation Expense	116,667	93,345	70,000	46,673	33,315
Net Book Value ending	243,333	149,988	79,988	33,315	-0-

Table #3 Financial Statement B/S Values

	20X1	20X2	20X3	20X4	20X5
Net Book Value beginning	360,000	288,000	216,000	144,000	72,000
Depreciation Expense	72,000	72,000	72,000	72,000	72,000
Net Book Value ending	288,000	216,000	144,000	72,000	-0-

The resulting differences between Tax Basis and Book Basis are as follows

Table #4 B/S Value Differences Between Tax Return and F/S

	20X1	20X2	20X3	20X4	20X5
NBV T/R Table #2	243,333	149,988	79,988	33,315	-0-
NBV F/S Table #3	288,000	216,000	144,000	72,000	-0-
year end differences	<44,667>	<66,012>	<64,012>	<38,685>	-0-
or decrease in year end differences	<44,667>	<21,345>	2,000	25,327	38,685

To illustrate Deferred Taxes, assume Book Income Before Taxes for the five years is as follows

20X1 $80,000

20X2 $82,000

20X3 $84,000

20X4 $86,000

20X5 $88,000

Total 420,000

Let us also assume a constant tax rate of 33% for all five years.

Using these amounts, book income versus taxable income and Income Tax Payable will be as follows

Table #5 Calculation of Current Tax Liability

	20X1	20X2	20X3	20X4	20X5	Total
Book Income	80,000	82,000	84,000	86,000	88,000	420,000
Depr diff Table #1	<44,667>	<21,345>	2,000	25,327	38,685	-0-
Taxable Income	35,333	60,655	86,000	111,327	126,685	420,000
Inc Tax Pay (33%)	11,660	20,016	28,380	36,738	41,806	138,600

DIT (the B/S liability for future taxes) can now be computed as follows using the Basic data from Tables 2, 3, and 4, coupled with the tax rate of 33%.

Table #6 Calculation of Deferred Income Tax (DIT)

	20X1	20X2	20X3	20X4	20X5
NBV tax table 2	243,333	149,988	79,988	33,315	-0-
NBV books table 3	288,000	216,000	144,000	72,000	-0-
Difference	<44,667>	<66,012>	<64,012>	<38,685>	-0-
Cumulative DIT x 33%	<14,740>	<21,784>	<21,124>	<12,766>	-0-
Dec in DIT	<14,740>	<7,044>	660	8,358	12,766

Table #7 - Resulting Correct Journal Entries

	20X1	20X2	20X3	20X4	20X5
Income Tax Expense	26,400	27,060	27,720	28,380	29,040
DIT Table 6	<14,740>	<7,044>	660	8,358	12,766
Inc Tax Pay Table 5	<11,660>	<20,016>	<28,380>	<36,738>	<41,806>
debit /
Book Inc Before Tax	80,000	82,000	84,000	86,000	88,000
effective tax rate	33.00%	33.00%	33.00%	33.00%	33.00%

REQUIREMENT #4

Use the information from the Basic Illustration EXCEPT that an $85,000 Net Operating Loss (NOL) was incurred in 20X2 rather than the $82,000 income in the Basic Illustration. Income in 20X3 was also different than the Basic Illustration assume $99,000 rather than $84,000. The tax rate for each year is to again 33%.

Calculation of DIT

	20X1	20X2	20X3	20X4	20X5
NBV T/R Table 2	243,333	149,988	79,988	33,315	-0-
NBV F/S Table 3	288,000	216,000	144,000	72,000	-0-
depreciation difference	<44,667>	<66,012>	<64,012>	<38,685>	-0-
Cumulative DIT x 33%	<14,740>	<21,784>	<21,124>	<12,766>	-0-
or decrease in DIT	<14,740>	<7,044>	660	8,358	12,766

Calculation of Income Tax Payable

	20X1	20X2	20X3	20X4	20X5	Total
Book Income	80,000	<85,000>	99,000	86,000	88,000	268,000
20X2 NOL carry forward	---	---	<71,012>	---	---	<71,012>
depreciation diff	<44,667>	<21,345>	2,000	25,327	38,685	---
Taxable Income or **	35,333	<106,345>	29,988	111,327	126,685	196,988
20X2 NOL carry back	---	35,333	---	---	---	35,333
Taxable Income or **	35,333	<71,012>	29,988	111,327	126,685	232,321
Income Tax Payable	11,660	---	9,896	36,738	41,806	100,100
Deferred NOL Asset		23,434

Journal entry (debit and )

	20X1	20X2	20X3	20X4	20X5
Income Tax Exp	26,400	<28,050>	32,670	28,380	29,040
Income Tax Receivable		11,660
Deferred NOL Asset		23,434	<23,434>
DIT	<14,740>	<7,044>	660	8,358	12,766
Income Tax Payable	<11,660>	---	<9,896>	<36,738>	<41,806>
Book Income Before Tax	80,000	<85,000>	99,000	86,000	88,000
effective tax rate	33.00%	33.00%	33.00%	33.00%	33.00%

Questions:

In the spaces provided below you are to answer the following questions

1 WHY are the journal entry debits and credits to DIT exactly the same in Requirement #4 for all five years as they were in the Basic Illustration? Your answer must be 30 words or less!

2 EXPLAIN (using dollar amounts and identifying labels) what the firm did with the $106,345 Tax Loss (NOL) from 20X2.

3 With Book Income Before Tax of $99,000 in 20X3, how much net Cash did the firm actually pay (or receive from) the IRS in 20X3?

(Use the information from the given basic illustration as well as the questions and requirement to complete problems)