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# Advanced Accounting Computing Income Tax Expense

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Computing Income Tax Expense

Swan Products Inc. owns 25 percent of Computech Computer Company's common stock, purchased December 28, 20X3, at book value. During the three years, subsequent to the acquisition of its stock by Swan Products, Computech reported the following net income and dividends:

20X4 20X5 20X6

Net Income \$20,000 \$8,000 \$40,000
Dividends 4,000 10,000 12,000

Swan has an effective income tax rate of 40 percent. All dividends it received from Computech qualify for the 80 percent dividend deduction.

Problem:
a) Compare the amount of income tax expense that Swan should have reported in its income statement for each of the three years with respect to its investment in Computech, assuming that Swan reports its investment using (1) the cost method and (2) the equity method
b) Present all journal entries related to its investment in Computech, including income tas effects, that Swan should have recorded for each of the three years, assuming Swan accounts for its investment using the cost method.
c) Present all journal entries related to its investment in Compputech, including income tas effects, that Swan should have recorded for each of the three years, assuming Swan accounts for its investment using the equity method.

#### Solution Preview

(a)
(1) Under cost method, the parent company doesn't revise its investment with respect to income or dividends received from subsidiary, hence it will be 0 for all years.
(2) Under equity method, we would have:
2004: 0.40*(0.80*(0.25*4,000) + 0.25*20,000) = 2,320
2005: 0.40*(0.80*(0.25*10,000) + 0.25*8,000) = 1,600
2006: 0.40*(0.80*(0.25*12,000) + 0.25*40,000) = 4,960

(b) The entries of the type for all years:
Dr. Investment in ...