Terry’s auditors have approached the management team with theirconcern that Terry has not been properly recording deferred taxes.In particular, they are concerned that Terry is simply recognizing25% as the company’s income tax expense. They have asked thecompany to make a thorough review of the company’s tax liabilityutilizing the services of professional tax accountants. The reviewrevealed three book/tax differences in Terry’s financialinformation:

The review revealed three book/tax differences in Terry’sfinancial information:

1.Terry’s management opened a new life insurance policy thisyear on the CEO. The premium for this new policy is $917/month. Thepolicy cannot be prepaid.

2. Up through Year 2, Terry had no book/tax differences foramortization and depreciation. This happens when companies use theMACRS tables for determining their depreciation and amortizationexpenses for both GAAP and tax purposes, a common practice amongsmall companies (like Terry). However, in Year 3, Terry decided toswitch to the straight-line depreciation method for GAAP purposes.Since this is a change in estimate, it did not require any specialchanges to Terry’s GAAP accounting, but it does create a differencefor tax purposes. A summary of the book/tax differences will beprovided by the instructor after we have completed Terry #3.

In addition, the experts feel that Terry’s tax rate will changeto 24% in Year 5 and to 23% in Years 6 & 7 due to new tax lawspassed and signed into law during Year 3.

CALCULATIONS

1. Make the appropriate journal entry to correctly record incometax expense for Year 3. (Please see the hints section for help withmaking these entries!)

	Year 3	Year 4	Year 5	Year 6
GAAP	($1,998,000)	($1,998,000)	($1,998,000)	($1,998,000)
Tax	($3,036,960)	($2,733,264)	($2,221,776)	$0