You have been assigned to compute the income tax provision for Sparrow Corporation. The company's income statement for 2020 is as follows: Sparrow Corporation Income Statement Year ended 12/31/2020 Net Sales $25,000,000 Cost of Sales 15,500,000 Gross Profit 9,500,000 Other Income: Dividends 200,000 Interest 50,000 Total Other Income 250,000 Gross Income 9,750,000 Expenses: Compensation 2,800,000 Depreciation 1,400,000 Charitable Donations 400,000 Meals and Entertainment 80,000 Other Expenses 3,000,000 Total Expenses 7,680,000 Income Before Income Taxes 2,070,000 You have identified the following permanent differences: Interest from municipal bonds $70,000 Nondeductible Meals and Entertainment Expenses 30,000 Dividend Received Deduction 140,000 1 Sparrow prepared the following schedule of temporary differences from the beginning of the year to the end of the year. Sparrow Corporation Temporary Difference Scheduling Template Taxable Temp BOY Beginning Current Year EOY Ending Differences Cumulative Deferred Change Cumulative Deferred T/D Taxes @ 21% T.D. Taxes @21% Non-Current Accumulated (3,000,000) (630,000) (500,000) (3,500,000) (735,000 Depreciation Deductible BOY Beginning Current Year EOY Ending Temporary Cumulative Deferred Change Cumulative Deferred Differences T/D Taxes @ 21% T.D. Taxes @21% Current Allowance for 100,000 21,000 30,000 130,000 27,300 Bad Debts Accrued 150,000 31,500 50,000 200,000 42,000 Warranties Total Current 250,000 52,500 80,000 330,000 69,300 Non-current Charitable 300,000 63,000 80,000 380,000 79,800 Contributions Deferred 500,000 105,000 (100,000) 400,000 84,000 Compensation Total Non- 800,000 168,000 (20,000) 780,000 163,800 Current Required: 1. Compute the current income tax expense or benefit for Sparrow assuming a 21% tax rate. 2. Compute Sparrow's deferred income tax expense or benefit. Provide the full entry to record the tax provision for the year. 3. Prepare a reconciliation of Sparrow's total income tax provision with its hypothetical income tax expense in both dollars and rates (compute the rate to the nearest hundredth of a percent (i.e. 21.62%). 4. Why is Sparrow's effective tax rate different from the statutory tax rate of 21%? Does this reflect good tax planning on Sparrow's part? What is the cost of achieving this effective tax rate? 5. Assume Sparrow's tax rate for the current year increased to 28%. Recompute Sparrow's deferred income tax expense or benefit for 2020 using the template on the following page. 6. Sparrow's tax director, Cardinal Grosbeak, believes the firm may actually be able to deduct the Meals and Entertainment Expense of $30,000 because the firm's manufacturing facility is far from any available restaurants. However, he is not confident that it is more likely than not the position would be sustained under audit. Assume the firm decides to tax this deduction on its tax return. Re-do the full journal entry for the tax position assuming the firm plans to take the deduction on its tax return. (Ignore question 5, and assume rate remains at 21%). 3 7. On December 27, 2020 Cardinal got a call from the IRS notifying him that the agency would not allow Sparrow a deduction for $13,000 in country club dues as a business expense from the 2016 tax return. As a result of the audit, Sparrow now owes the IRS an additional $4,420 in tax payments related to 2015. At the time of filing the return, Cardinal had some concerns about whether they would be allowed to deduct the country club dues and had set up a reserve for uncertain tax benefits of $3,000 related to the tax position. Record the necessary journal entry given this new information. Assume Sparrow will make the payment in January of 2021. Sparrow Corporation Taxable Temp Differences Temporary Difference Scheduling Template BOY Beginning Current Year EOY Cumulative Deferred Change Cumulative T/D Taxes @ 21% T.D. Ending Deferred Taxes @28% Non-Current (3,000,000) (630,000) (500,000) (3,500,000) Accumulated Depreciation Deductible Temporary Differences BOY Cumulative T/D Beginning Deferred Taxes @ 21% Current Year Change EOY Cumulative T.D. Ending Deferred Taxes @28% 100,000 21,000 30,000 130,000 Current Allowance for Bad Debts Accrued Warranties 150,000 31,500 50,000 200,000 Total Current 250,000 52,500 80,000 330,000 300,000 63,000 80,000 380,000 Non-current Charitable Contributions Deferred Compensation Total Non- 500,000 105,000 (100,000) 400,000 800,000 168,000 (20,000) 780,000 Current You have been assigned to compute the income tax provision for Sparrow Corporation. The company's income statement for 2020 is as follows: Sparrow Corporation Income Statement Year ended 12/31/2020 Net Sales $25,000,000 Cost of Sales 15,500,000 Gross Profit 9,500,000 Other Income: Dividends 200,000 Interest 50,000 Total Other Income 250,000 Gross Income 9,750,000 Expenses: Compensation 2,800,000 Depreciation 1,400,000 Charitable Donations 400,000 Meals and Entertainment 80,000 Other Expenses 3,000,000 Total Expenses 7,680,000 Income Before Income Taxes 2,070,000 You have identified the following permanent differences: Interest from municipal bonds $70,000 Nondeductible Meals and Entertainment Expenses 30,000 Dividend Received Deduction 140,000 1 Sparrow prepared the following schedule of temporary differences from the beginning of the year to the end of the year. Sparrow Corporation Temporary Difference Scheduling Template Taxable Temp BOY Beginning Current Year EOY Ending Differences Cumulative Deferred Change Cumulative Deferred T/D Taxes @ 21% T.D. Taxes @21% Non-Current Accumulated (3,000,000) (630,000) (500,000) (3,500,000) (735,000 Depreciation Deductible BOY Beginning Current Year EOY Ending Temporary Cumulative Deferred Change Cumulative Deferred Differences T/D Taxes @ 21% T.D. Taxes @21% Current Allowance for 100,000 21,000 30,000 130,000 27,300 Bad Debts Accrued 150,000 31,500 50,000 200,000 42,000 Warranties Total Current 250,000 52,500 80,000 330,000 69,300 Non-current Charitable 300,000 63,000 80,000 380,000 79,800 Contributions Deferred 500,000 105,000 (100,000) 400,000 84,000 Compensation Total Non- 800,000 168,000 (20,000) 780,000 163,800 Current Required: 1. Compute the current income tax expense or benefit for Sparrow assuming a 21% tax rate. 2. Compute Sparrow's deferred income tax expense or benefit. Provide the full entry to record the tax provision for the year. 3. Prepare a reconciliation of Sparrow's total income tax provision with its hypothetical income tax expense in both dollars and rates (compute the rate to the nearest hundredth of a percent (i.e. 21.62%). 4. Why is Sparrow's effective tax rate different from the statutory tax rate of 21%? Does this reflect good tax planning on Sparrow's part? What is the cost of achieving this effective tax rate? 5. Assume Sparrow's tax rate for the current year increased to 28%. Recompute Sparrow's deferred income tax expense or benefit for 2020 using the template on the following page. 6. Sparrow's tax director, Cardinal Grosbeak, believes the firm may actually be able to deduct the Meals and Entertainment Expense of $30,000 because the firm's manufacturing facility is far from any available restaurants. However, he is not confident that it is more likely than not the position would be sustained under audit. Assume the firm decides to tax this deduction on its tax return. Re-do the full journal entry for the tax position assuming the firm plans to take the deduction on its tax return. (Ignore question 5, and assume rate remains at 21%). 3 7. On December 27, 2020 Cardinal got a call from the IRS notifying him that the agency would not allow Sparrow a deduction for $13,000 in country club dues as a business expense from the 2016 tax return. As a result of the audit, Sparrow now owes the IRS an additional $4,420 in tax payments related to 2015. At the time of filing the return, Cardinal had some concerns about whether they would be allowed to deduct the country club dues and had set up a reserve for uncertain tax benefits of $3,000 related to the tax position. Record the necessary journal entry given this new information. Assume Sparrow will make the payment in January of 2021. Sparrow Corporation Taxable Temp Differences Temporary Difference Scheduling Template BOY Beginning Current Year EOY Cumulative Deferred Change Cumulative T/D Taxes @ 21% T.D. Ending Deferred Taxes @28% Non-Current (3,000,000) (630,000) (500,000) (3,500,000) Accumulated Depreciation Deductible Temporary Differences BOY Cumulative T/D Beginning Deferred Taxes @ 21% Current Year Change EOY Cumulative T.D. Ending Deferred Taxes @28% 100,000 21,000 30,000 130,000 Current Allowance for Bad Debts Accrued Warranties 150,000 31,500 50,000 200,000 Total Current 250,000 52,500 80,000 330,000 300,000 63,000 80,000 380,000 Non-current Charitable Contributions Deferred Compensation Total Non- 500,000 105,000 (100,000) 400,000 800,000 168,000 (20,000) 780,000 Current