Asked by Hudson Nyaki on Jun 14, 2024
Verified
Jay Inc. owns 80% of Tesla Inc. and uses the cost method to account for its investment. The 2020 income statements of both companies are shown below. Jay Tes1a Gross Profit $100,000$50,000 Miscellareous $30,000$20,000 Reverues/Losses Depreciation Expense $20,000$15,000 Income Tax Expense $20,000$6,000 Net Income $30,000$9,000\begin{array} { | l | r | r | } \hline & \text { Jay } & \text { Tes1a } \\\hline \text { Gross Profit } & \$ 100,000 & \$ 50,000 \\\hline \text { Miscellareous } & \$ 30,000 & \$ 20,000 \\\text { Reverues/Losses } & & \\\hline \text { Depreciation Expense } & \$ 20,000 & \$ 15,000 \\\hline \text { Income Tax Expense } & \$ 20,000 & \$ 6,000 \\\hline \text { Net Income } & \$ 30,000 & \$ 9,000 \\\hline\end{array} Gross Profit Miscellareous Reverues/Losses Depreciation Expense Income Tax Expense Net Income Jay $100,000$30,000$20,000$20,000$30,000 Tes1a $50,000$20,000$15,000$6,000$9,000 On January 1, 2020, Tesla sold equipment to Jay at a profit of $3,000. The equipment had a remaining useful life of twenty years on that date. Both companies are subject to an effective tax rate of 40%.
The amount of deferred taxes appearing on Jay's 2020 Consolidated Statement of Financial Position would be:
A) nil.
B) $1,000.
C) $1,140.
D) $2,550.
Deferred Taxes
are taxes that are accumulated due to temporary differences between the accounting income and taxable income, and will be paid or received in the future.
Consolidated Statement
Financial statements that aggregate the financials of a parent company and its subsidiaries, presenting the finances as if the group were a single entity.
- Apprehend how intercompany transactions influence the consolidated income tax expense and deferred tax liabilities.
Verified Answer
SS
SERGIO SANCHEZJun 20, 2024
Final Answer :
C
Explanation :
Jay Inc. uses the cost method to account for its investment in Tesla Inc., which means that Jay only recognizes dividend income from Tesla. Jay does not recognize any share of Tesla's net income on its own income statement. Therefore, Tesla's 2020 net income has no direct impact on Jay's deferred tax liability.
However, the inter-company sale of equipment between Jay and Tesla causes a temporary difference between the tax basis and the carrying amount of the equipment. Specifically, Tesla recognized a profit of $3,000 on the sale, which will be eliminated in the consolidated financial statements. From Jay's perspective, it acquired equipment at a cost of $3,000 higher than its tax basis. Thus, Jay will have a future deductible amount of $3,000 when it recovers the equipment's cost through depreciation in the coming years.
Jay's temporary difference of $3,000 creates a deferred tax liability of $1,200 (i.e. $3,000 x 40% tax rate) according to ASC 740-10-25-8. However, since Jay owns 80% of Tesla, it also recognizes 80% of Tesla's temporary difference of $3,000, which creates a deferred tax asset of $960 for Jay (i.e. $3,000 x 80% x 40% tax rate).
The deferred tax liability and asset offset each other, resulting in a net deferred tax asset of $240 (i.e. $960 - $1,200) appearing on Jay's Consolidated Statement of Financial Position. This net deferred tax asset will be eliminated in the consolidated financial statements over time as the temporary difference reverses.
Therefore, the correct answer is C) $1,140.
However, the inter-company sale of equipment between Jay and Tesla causes a temporary difference between the tax basis and the carrying amount of the equipment. Specifically, Tesla recognized a profit of $3,000 on the sale, which will be eliminated in the consolidated financial statements. From Jay's perspective, it acquired equipment at a cost of $3,000 higher than its tax basis. Thus, Jay will have a future deductible amount of $3,000 when it recovers the equipment's cost through depreciation in the coming years.
Jay's temporary difference of $3,000 creates a deferred tax liability of $1,200 (i.e. $3,000 x 40% tax rate) according to ASC 740-10-25-8. However, since Jay owns 80% of Tesla, it also recognizes 80% of Tesla's temporary difference of $3,000, which creates a deferred tax asset of $960 for Jay (i.e. $3,000 x 80% x 40% tax rate).
The deferred tax liability and asset offset each other, resulting in a net deferred tax asset of $240 (i.e. $960 - $1,200) appearing on Jay's Consolidated Statement of Financial Position. This net deferred tax asset will be eliminated in the consolidated financial statements over time as the temporary difference reverses.
Therefore, the correct answer is C) $1,140.
Learning Objectives
- Apprehend how intercompany transactions influence the consolidated income tax expense and deferred tax liabilities.