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%

REQUIREMENT #2

Use the information from the Basic Illustration EXCEPT that a new tax rate was enacted and changed in 20X4.

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-
tax rate	33%	33%	33%	37%	37%
cumulative DIT x tax rate	<14,740>	<21,784>	<21,124>	<14,313>	-0-
or decrease in DIT	<14,740>	<7,044>	660	6,811	14,313

Calculation of Income Tax Payable

	20X1	20X2	20X3	20X4	20X5	Total
Book Inc Before Tax	80,000	82,000	84,000	86,000	88,000	420,000
depreciation diff	<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
tax rate	33%	33%	33%	37%	37%
Income Tax Payable	11,660	20,016	28,380	41,191	46,873	148,120

Journal entry (debit and )

	20X1	20X2	20X3	20X4	20X5
Income Tax Expense	26,400	27,060	27,720	34,380	32,560
DIT	<14,740>	<7,044>	660	6,811	14,313
Income Tax Payable	<11,660>	<20,016>	<28,380>	<41,191>	<46,873>
Book Inc Before Tax	80,000	82,000	84,000	86,000	88,000
effective tax rate	33.00%	33.00%	33.00%	39.98%	37.00%

In the space below, TYPE your explanation in words and a supporting calculation on WHY (i.e., what caused the effective rate in 20X4 to be 39.98% rather than 37%. Be sure your calculation shows how the 39.98% 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 this does not yield an answer of 37%, or even 33%. What makes it 39.98% in 20X4?