Duncanville Company appropriately uses the installment sales method for tax purposes and the accrual method for revenue recognition for accounting purposes.Pertinent data at December 31, 2010, the close of the first year of operations, are as follows: $\begin{array}{lll}
& \text { Revenue Recognized } & \text { Revenue Recogrized } \
\text { Customer } & \text { for Accounting Purposes } & \text { for Tax} \text { Purposes }\
\text { Ace'sBuilders } & \$ 200,000 & \$ 100,000 \
\text { Tip Top Plumbing } & 500,000 & 350,000 \
\text { Clearly Windows } & 600,000 & 350,000
\end{array}$
Duncanville's tax rate is 30%.What amount should be included in the deferred tax account at December 31, 2010 for these installment sales?

Question

Duncanville Company appropriately uses the installment sales method for tax purposes and the accrual method for revenue recognition for accounting purposes.Pertinent data at December 31, 2010, the close of the first year of operations, are as follows: $\begin{array}{lll}
& \text { Revenue Recognized } & \text { Revenue Recogrized } \
\text { Customer } & \text { for Accounting Purposes } & \text { for Tax} \text { Purposes }\ 
 \text { Ace'sBuilders } & \$ 200,000 & \$ 100,000 \
\text { Tip Top Plumbing } & 500,000 & 350,000 \
\text { Clearly Windows } & 600,000 & 350,000
\end{array}$
 Duncanville's tax rate is 30%.What amount should be included in the deferred tax account at December 31, 2010 for these installment sales?

Quizplus · Accepted Answer

Under the installment sales method, income is recognized in the year that cash is received, even though the sale may span multiple years. However, for tax purposes, income is recognized in the year the sale is made. This creates a timing difference between accounting income and taxable income.

Since Duncanville uses the accrual method for accounting purposes, they will recognize all revenue immediately when it is earned, regardless of whether payment is received. This means that Duncanville will have recognized more revenue for accounting purposes than for tax purposes.

Therefore, at the end of the first year of operations, Duncanville will have a deferred tax liability because they will owe more taxes in future years when they collect the remaining payments on the installment sales.

The amount of the deferred tax liability can be calculated as follows:

Total installment sales recognized for accounting purposes = $2,000,000
Total installment sales recognized for tax purposes =$500,000 (assuming they made one sale for $2,000,000 and recognized $500,000 of that as income for tax purposes).
Timing difference = $2,000,000 - $500,000 = $1,500,000
Deferred tax liability = $1,500,000 x 30% (tax rate) = $450,000

Therefore, choice B is the correct answer, with a deferred tax liability of $450,000, which is the closest option to $500,000.

Duncanville Company Appropriately Uses the Installment Sales Method for Tax