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    Geraldo Corporation's audited financial statements

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    Geraldo, a calendar-year, accrual-basis corporation reported $931,000 net income before tax on its audited financial statements. Its records reveal the following information:

    - On February 1, Geraldo purchased a business and capitalized $500,000 of the cost to goodwill.
    - Book depreciation expense was $66,100, and MACRS depreciation was $77,800.
    - Geraldo paid an $18,500 premium for its employee group term life insurance plan and a $5,900 premium for its key-person life insurance policies.
    - Geraldo accrued a $35,000 expense for the estimated settlement of a breach-of-contract suit that should go to court next year.

    a. Compute Geraldo's taxable income.
    b. Compute Geraldo's federal tax expense per books and federal tax payable.
    c. Explain why tax liability and book-tax expense are different and indicate whether the difference is permanent or temporary.

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    Solution Preview

    Tax liability and book-tax expense are different because some transactions cannot be accounted for until the year realized. According to Jones and Rhodes-Catanach, "The tax rules governing the recognition of income or gain and the deduction of expense or loss can create a permanent difference between book income and taxable income" (2004). For the purpose of this work paper, permanent differences are goodwill and key-person life insurance policies.

    All items must be recorded for book expense because these expenses happened in the current year. However, for tax purposes, estimated future legal expenses are excluded from the current year income because they have not yet ...

    $2.19