Lewes 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, 2014, the close of the first year of operations, are as follows:
Lewes's tax rate is 30%. What amount should be included in the deferred tax account at December 31, 2014 for these installment sales?

Question

Lewes 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, 2014, the close of the first year of operations, are as follows: 
 Lewes's tax rate is 30%. What amount should be included in the deferred tax account at December 31, 2014 for these installment sales?

Quizplus · Accepted Answer

Since Lewes Company uses the installment sales method for tax purposes, it recognizes its revenue when cash is collected. However, for accounting purposes, revenue recognition is based on the percentage of completion method. As the revenue has not been fully realized but only partly at the end of the first year of operations, there is a temporary difference between tax and accounting records. This temporary difference creates a deferred tax liability because Lewes will have to pay taxes on the remaining installment payments in future but has not yet recognized the revenue for those payments in its accounting records. Therefore, the amount that should be included in the deferred tax account at December 31, 2014 for these installment sales is $150,000 (50% of the deferred tax liability of $300,000).

Lewes Company Appropriately Uses the Installment Sales Method for Tax