Class Test 1

Time: 20 Minutes Marks: 5%

Instructions: Mark your choice of correct answer. Provide detailed workings to support your
choice of answer. In absence of correct workings, your answer will be considered as deemed
incorrect.

Q1 Shear, Inc. began operations in 2003.
Included in Shears 2003 financial
statements were bad debt expenses of $1,400
and profit from an installment sale of
$2,600. For tax purposes, the bad debts will
be deducted and the profit from the
installment sale will be recognized in 2004.
The enacted tax rates are 30% in 2003 and
25% in 2004. In its 2003 income statement,
what amount should Shear report as deferred
income tax expense?
a.$300
b.$360
c.$650
d.$780
Q2 On its December 31, 2003 balance sheet,
Shin Co. had income taxes payable of
$13,000 and a current deferred tax asset of
$20,000 before determining the need for a
valuation account. Shin had reported a
current deferred tax asset of $15,000 at
December 31, 2002. No estimated tax
payments were made during 2003. At
December 31, 2003, Shin determined that it
was more likely than not that 10% of the
deferred tax asset would not be realized. In
its 2003 income statement, what amount
should Shin report as total income tax
expense?
a.$ 8,000
b.$ 8,500
c.$10,000
d.$13,000


1. (a)
(a) The deferred portion of income tax expense can be computed by determining the tax effect of the two temporary differences.
The installment sale profit results in a future taxable amount in 2004 of $2,600, and the bad debt expense results in a future
deductible amount of $1,400.
The deferred tax consequences of these temporary differences will be measured by Shear in 2003 using the enacted tax rate
expected to apply to taxable income in the year the deferred amounts are expected to be settled. The following journal entry is
necessary to record the deferred tax liability related to the installment sale:
Deferred tax expense 650
Deferred tax liability 650
[$2,600 x .25]
To record the deferred tax asset related to the bad debt expense, the following journal entry is required:
Deferred tax asset 350
Deferred tax expense 350
[$1,400 x .25]
The amount of deferred tax expense to be reported by Shear in its 2003 income statement is $300 ($650 $350). Note that one
journal entry could have been used. Using two entries more clearly shows the opposite effect of an asset versus a liability on
deferred tax expense.
Here journal entries are included to provide you the understanding. However, for examination purposes, calculations supporting the
deferred tax asset amounts, the deferred tax liability amounts and the deferred tax expense amount would have been suffice.

2. (c)
From 12/31/02 to 12/31/03, the deferred tax asset increased by $5,000 (from $15,000 to $20,000). Income taxes payable at
12/31/03 are $13,000. Based on this information, the following journal entries can be recreated.
Income tax expensecurrent 13,000
Income tax payable 13,000

Deferred tax asset 5,000
Income tax expensedeferred 5,000
An additional entry would be prepared by Shin to record an allowance to reduce the deferred tax asset to its realizable value (10% x
$20,000 = $2,000).
Income tax expensedeferred 2,000
Allowance to reduce deferred
tax asset to realizable value 2,000
Based on these three entries, total 2003 income tax expense is $10,000 ($13,000 $5,000 + $2,000).

Income Tax expense presentation in the income statement would be:

Income Tax Expense
Income tax Payable 13,000
Less: Deferred tax asset (5,000)
Add: Allowance to reduce DTA 2000





10,000