Highridge Enterprises, Inc. manufactures high capacity commercial water filtration systems. It is not uncommon for Highridge to sell these systems on an installment basis, recognizing gross profit in the period of sale for GAAP purposes, and as receipts are collected for tax purposes. In 20X1, Highridge sold eight systems on an installment basis generating total gross profit of $3,200,000. Twenty five percent of each sale is collected in the current year (20X1), with the remaining seventy five percent being collected evenly over the three following years (20X2, 20X3, and 20X4).
Highridge warrants the systems it sells against manufacturer defects. In 20X1, the company recognized $682,000 of warranty expense for GAAP purposes, while incurring actual costs of $130,000. Warranty costs of $374,000 and $460,000 are expected in 20X2 and 20X3 respectively.
On January 2, 20X1, Highridge received $600,000 from a company that rents a warehouse that it owns. The amount received is for 20X1 and 20X2 ($300,000 per year).
Highridge’s plant and equipment are depreciated as follows for GAAP and Tax purposes:
Year GAAP Tax
20X1 $1,015,000 $1,700,000
20X2 1,015,000 1,550,000
20X3 1,015,000 970,000
20X4 1,015,000 950,000
20X5 1,015,000 820,000
20X6 1,015,000 790,000
20X7 1,015,000 720,000
20X8 1,015,000 680,000
20X9 1,015,000 420,000
20X10 - 0 - 180,000
Highridge invests idle funds in municipal bonds and earned $31,000 in 20X1. The company paid fines and penalties of $42,000 and life insurance premiums (policies covering key executives) of $23,000 in 20X1.
Two years ago, Highridge paid taxes of $497,344, and paid taxes of $521,340 last year. Tax rates in those years were 32% and 34% respectively (32% two years ago, 34% last year). To enhance current cash flow, Highridge carries back operating losses whenever they are incurred. Last year, Highridge’s ending Deferred Tax Asset and Deferred Tax Liability balances were $615,520 and $788,220 respectively. Enacted tax rates are as follows: 20X1 – 36%; 20X2 through 20X4 – 38%; 20X5 and beyond – 40%. Highridge’s pretax GAAP income in 20X1 was $812,000.
ACC440 External Financial Reporting II
Chapter 16 Accounting for Income Taxes
Offline Homework Assignment
In 20X2, Highridge sold fourteen filtration systems on an installment basis generating $4 million in gross
profit. Twenty five percent of the sales were collected in 20X2, with the remaining seventy five percent
being collected evenly over the next three years (20X3, 20X4, and 20X5).
Highridge continued to warrant the systems it sold in 20X2 against defects, recognizing $930,000 of
expense for GAAP purposes, while incurring $421,500 in warranty repair costs. Remaining warranty
costs (in total for all outstanding warranty obligations) are expected to be incurred as follows: 20X3 -
$486,000, 20X4 - $534,000.
On December 20, 20X2, Highridge received $800,000 from the company that rents one of its
warehouses. The amount received is for 20X3 and 20X4 ($400,000 per year).
Highridge continued to invest in municipal bonds during 20X2, earning $31,000 in interest. The company
paid $23,000 for life insurance premiums and paid $48,000 in fines and penalties. Sadly, one of the
company’s executives lost their life in an automobile accident. The executive’s life was insured by the
company and a $2,000,000 death benefit was received on June 18, 20X2. The company continued to
depreciate it’s assets as indicated above (no asset acquisitions or disposals occurred).
Highridge reported pretax GAAP income of $3,890,500 for 20X2. Enacted tax rates are as follows: 20X2
through 20X4 – 38%; 20X5 and beyond – 40%.
Prepare Step 1 and Step2 schedules for 20X1 and 20X2 and related journal entries. Also indicate the
amount of income tax expense (current and deferred separately) that will be reported on Highridge’s
income statement for 20X1 and 20X2.