Question33 Lucy Ltd commenced operations in the current year and has the following balance for its accounts receivable at year end: [table]
| $ Accounts receivable | 200 000 Less: Allowance for bad debts | (10 000) Net accounts receivable | 190 000 Bad debt expense | 15 000
[/table] The income tax rate is 30%. The journal to record the tax effect of this is: DR Income tax expense $3 000 / CR Deferred tax liability $3 000. DR Income tax expense $3 000 / CR Deferred tax asset $3 000. DR Deferred tax asset $4 500 / CR Income tax expense $4 500. DR Deferred tax liability $3 000 / CR Income tax expense $3 000. DR Deferred tax asset $3 000 / CR Income tax expense $3 000. ResetMaximum marks: 1 Flag question undefined

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BlackTom AI · Accepted Answer

Question and options restated: The problem shows Lucy Ltd has accounts receivable ending balance of $200,000, less allowance for bad debts of ($10,000), net accounts receivable $190,000, and bad debt expense $15,000. Tax rate is 30%. We are to determine the journal to record the tax effect of this difference, choosing among:

1) DR Income tax expense $3,000 / CR Deferred tax liability $3,000.
2) DR Income tax expense $3,000 / CR Deferred tax asset $3,000.
3) DR Deferred tax asset $4,500 / CR Income tax expense $4,500.
4) DR Deferred tax liability $3,000 / CR Income tax expense $3,000.
5) DR Deferred tax asset $3,000 / CR Income tax expense $3,000.

Option 1 analysis: This entry increases Income Tax Expense and creates a Deferred Tax Liability. A liability suggests the entity will pay more tax in the future due to a taxable temporary difference. In the context of bad debts and allowance, the typical outcome is either a deferred tax asset or no liability, not an additional tax payable as a liability, so this is unlikely to be correct given a deductible temporary difference is usually reflected as an asset.

Option 2 analysis: This entry increases Income Tax Expense and creates a Deferred Tax Asset. It records a deferred tax asset of $3,000, implying a deductible temporary difference that will reduce future taxes. If the accounting treatment creates a deductible difference (for example, the tax base for the bad debt allowance differs from the accounting carrying amount), a DTA can arise. This is plausible, but we must check consistency with the given numbers.

Option 3 analysis: This entry records a Deferred Tax Asset of $4,500 and decreases (reduces) Income Tax Expense by $4,500. The amount $4,500 corresponds to 15,000 × 30%. This would imply the entire bad debt expense of $15,000 is a deductible temporary difference for tax purposes, creating a larger asset. However, standard practice is to recognize the tax effect of the timing difference between accounting treatment and tax base, and $4,500 would only be appropriate if the full $15,000 bad debt expense is deductible for tax in the period and creates a DTA of $4,500, which contradicts the given answer options and the typical presentation here.

Option 4 analysis: This entry debits Deferred Tax Liability by $3,000 and credits Income Tax Expense by $3,000. A DTL would arise if taxable income is higher now than accounting income due to timing differences that will reverse in the future. With bad debt allowances, the usual effect is a deferred tax asset (deductible timing difference) rather than a liability, making this option unlikely unless there is a taxable temporary difference in the opposite direction.

Option 5 analysis: This entry debits Deferred Tax Asset $3,000 and credits Income Tax Expense $3,000. This creates a net decrease in the current tax expense via a deferred tax asset, reflecting a deductible timing difference of $3,000 (30% of $10,000 or related amount depending on base). This aligns with recognizing a DTA for timing differences arising when the accounting expense exceeds the tax deduction today, indicating future tax relief.

Synthesis of reasoning across options: The core is to identify whether the difference between accounting treatment (bad debt expense and allowance) and tax treatment results in a deferred tax asset or a deferred tax liability, and to quantify it with the appropriate tax rate. In this scenario, the provided correct choice corresponds to recognizing a deferred tax asset of $3,000 and reducing current tax expense accordingly. The other options either propose a liability or an asset amount that does not match the underlying timing difference or treat the entire bad debt expense as deductible without nuance, which is inconsistent with typical tax accounting for allowances and bad debt provisions.

Final judgment (based on the given correct answer in the data): The appropriate journal entry is to recognize a deferred tax asset of $3,000 and reduce income tax expense by $3,000, i.e., DR Deferred tax asset $3,000 / CR Income tax expense $3,000.

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