Acme, Inc. purchased machinery at the beginning of 2007 for $50,000. Management used the…

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Acme, Inc. purchased machinery at the beginning of 2007 for $50,000. Management used the straight-line method to depreciate the cost for financial reporting purposes and the doubledeclining-balance method to depreciate the cost for tax purposes. The life of the machinery was estimated to be four years, and the salvage value was estimated as zero. Revenue less expenses other than depreciation (for financial reporting and tax purposes) equaled $100,000 in 2007, 2008, 2009, and 2010. Acme pays income taxes at the rate of 35 percent of taxable income.


a. Prepare the journal entries to accrue income tax expense and income tax liability for 2007, 2008, 2009, and 2010. Indicate the balance in the deferred income tax account as of the end of each of the four years.

b. Assume that the federal government changed the tax rate to 20 percent at the beginning of 2009. Repeat the exercise in (a). Would it be appropriate to recognize a gain at the end of 2009 to reflect the tax rate decrease? Why or why not? If so, how much of a gain?

c. Assume that Acme purchased additional machinery at the beginning of 2008 and 2010. Each purchase was for $50,000, and each machine had a four-year estimated life and no salvage value. Once again, the straight-line depreciation method was used for reporting purposes and double-declining-balance for tax purposes. Repeat the exercise in (a) assuming a tax rate of 35 percent. Why is the deferred income tax account one of the largest liabilities on the balance sheets of many major U.S. companies?

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