Milo Manufacturing uses straight-line depreciation for financial statement reporting and is able to deduct 100% of the cost of equipment in the year the equipment is purchased for tax purposes. Four years after its purchase, one of Milo's manufacturing machines has a book value of $660,000. There were no other temporary differences and no permanent differences. Taxable income was $16 million and Milo's tax rate is 25%. What is the deferred tax liability to be reported in the balance sheet? Assuming that the deferred tax liability balance was $205,000 the previous year, prepare the appropriate journal entry to record income taxes this year.

Part a: The Deferred Tax Liability is $165,000.

Part b: The Journal Entry is as indicated in the explanation.

Explanation:

Part a:

Tax basis of machine = 0

Book basis of machine = $660,000

Required balance in deferred tax liability at the end of year is given as

($660,000-0) * 25% = $165,000

So the Deferred Tax Liability is $165,000.

Part b:

Current balance in deferred tax liability = $205,000

Reversal of deferred tax to be recorded in this year = $205,000 - $165,000 = $40,000

Income tax payable for the year = $16,000,000 * 25% = $4,000,000

Journal Entries

Event Particulars Debit Credit

1 Income tax expense Dr $3,960,000.00

Deferred tax liability Dr $40,000.00

To Income taxes payable $4,000,000.00

(To record income tax expense)