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%

Use this new information below along with the basic illustration to answer the questions

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:

1 WHY are the journal entry debits and credits to DIT exactly the same in Requirement #3 for all five years as they were in the Basic Illustration? Your answer must be 30 words or less!

2 WHY is the Income Tax Payable amount for 20X1, 20X3, and 20X4 smaller in Requirement #3 than in the Basic Illustration even though Book Income Before Tax is identical? Again, your answer must be 30 words or less!

3 Why is Income Tax Payable for 20X1 a total of $6,600 less for Requirement #3 compared to the Basic Illustration ($11,660 $5,060 = $6,600)? Your answer should be in the form of a mathematical proof as to what is causing the $6,600 difference.

4 WHY (i.e., what caused) the effective tax rate to be 30.05% in 20X3 rather than 33.00%? Be sure your calculation shows how the 30.05% is determined - this does NOT mean your answer is you divide Income Tax Expense by Book Income Before Tax. The issue to address is WHY it is 30.05% rather than 33.00%. Your answer should be in the form of a mathematical explanation of what is causing the 2.95% difference.