Andy McDowell Co. establishes a \(100 million liability at the end of 2017 for the estimated site-cleanup costs at two of its manufacturing facilities. All related closing costs will be paid and deducted on the tax return in 2018. Also, at the end of 2017, the company has \)50 million of temporary differences due to excess depreciation for tax purposes, \(7 million of which will reverse in 2018. The enacted tax rate for all years is 40%, and the company pays taxes of \)64 million on \(160 million of taxable income in 2017. McDowell expects to have taxable income in 2018. Instructions (a) Determine the deferred taxes to be reported at the end of 2017. (b) Indicate how the deferred taxes computed in (a) are to be reported on the balance sheet. (c) Assuming that the only deferred tax account at the beginning of 2017 was a deferred tax liability of \)10,000,000, draft the income tax expense portion of the income statement for 2017, beginning with the line “Income before income taxes.” (Hint: You must first compute (1) the amount of temporary difference underlying the beginning $10,000,000 deferred tax liability, then (2) the amount of temporary differences originating or reversing during the year, and then (3) the amount of pretax financial income.)

Step by step solution

01

(a) Preparation of the deferred tax schedule

Temporary difference	Amount	Tax rate	Deferred tax asset	Deferred tax liability	Balance sheet	Subhead
Estimated cost of books	$100 million	40%	($40 million)		Estimated payable	Current
Excess depreciation	$50 million	40%		$20 million	Plan assets	Non-current

02

(b) Indication of the amounts

Balance Sheet
Liabilities	Amount
Long-term liabilities
Deferred tax liability	$20 million
Assets	Amount
Current assets
Deferred tax assets	$40 million

03

(c) Income statement

Income statement
Particulars		Amount
Income before income taxes		$85 million
Less: income tax expense
Current$\left(\$160\mathrm{million}\times 40\%\right)$	$64 million
Deferred$\left(-\$40\mathrm{million}+\$10\mathrm{million}\right)$	($30 million)	$34 million
Net Income		$51 million

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