Reference no: EM13752419

Montclair Corporation designs and manufactures wind turbine generating systems and sells them to private energy producers. Many of their sales are structured to allow their customers to pay for equipment on an installment basis. In 2001 Montclair sold 10 units on installment resulting in %1.5 million of gross profit being reported for GAAP purposes. Payment for these sales will be received evenly over a 3 year period starting with the current year. In 2002, Montclair sold 12 units on installment resulting in $1.8 million of gross profit being reported on the income statement. Montclair changed the structure of these sales so that payments would be received evenly over a 2 year period starting with the current periods.

Montclair provides warranties on the units it sells. In 2001, the company estimated that it would incur $780,000 during the 3 year warranty period and accrued this amount for financial purposes. During 2001, Montclair incurred $132,000 to perform warranty related repairs. Expected warranty costs associated with 2001 sales in 2002 and 2003 were $352,000 and $296,000 respectively. Montclair continued to offer warranties on the units it sold in 2002 and estimated the cost associated with the coverage to be $931,000 (this amount was accrued for financial purposes). Costs incurred during the year to provide warranty services totaled $500,000 (for units sold in 2001 and 2002). Remaining total warranty costs of $521,000 and $270,000 and $288,000 were expected for 2003, 2004, and 2005 respectively.

Montclair uses a wide range of capital assets to produce its products, which it depreciates on a straight line basis for financial reporting purposes. The company depreciates the assets on an accelerated basis for tax purposes as follows:

                                Book                      Tax

2001                       $1,400,000           $2,000,600

2002                       $1,400,000           $3,428,600

2003                       $1,400,000           $2,448,600

2004                       $1,400,000           $1,748,600

2005                       $1,400,000           $1,250,200

2006                       $1,400,000           $1,248,800

2007                       $1,400,000           $1,250,200

2008                       $1,400,000           $624,400

2009                       $1,400,000           0

2010                       $1,400,000           0

Montclair rents power generating equipment for which they are paid in advance of the rental period commencing. In 2001, the company received $500,000 for contracts associated with 2 year rental terms that start on January 1, 2001. The company received $600,000 for similar contracts in 2002. Montclair invests idle funds in various types of investments, which include municipal bonds. The company reported interest earned in the bonds of $24,000 and $26,000 in 2001 and 2002 respectively.

Montclair insures the lives of its executives. Premiums associated with the policies were $12,000 per year in 2001 and 2002. Sadly, a senior executive covered by one of the policies lost her life in an automobile accident in 2002. Per the policy terms, Montclair received a death benefit of $5,000,000.

In 2002 Montclair was fined $10,000 for violating highway safety rules when delivering one of its products to a customer. Also in 2002, the company became involved in a lawsuit, which the company’s legal counsel felt would likely result in an adverse outcome for Montclair. The resulting loss was estimated to be in a range from $2,000,000 to $8,000,000. The appropriate amount was accrued for financial purposes. The anticipated settlement does not represent a fine or penalty and is expected to be paid in 2004.

Montclair reported income before taxes of $532,400 and $5,831,740 in 2001 and 2002 respectively. On its 2000 balance sheet, it reported a deferred tax asset of $1,307,861 (debit) and a deferred tax liability of $1,231,252 (credit). Two years prior to 2001, Montclair reported income for tax purposes of $245,270 and had a tax rate of 32%. One year prior to 2001 (2000), the company reported income for tax purposes of $325,660 and had a tax rate of 34%. Assume that Montclair carries back NOLs to the extent possible and utilizes NOL carry forwards as early as it can. Tax rates for Montclair are as follows:

2001 – 34%

2002 to 2004 – 36%

2005 and beyond – 38%

Required:

Prepare step 1 and step 2 schedules for 2001 and 2002. Prepare the required journal entries to account for Montclair’s income taxes for 2001 and 2002 (be sure to prepare your entries in conformity with Montclair’s NOL policy).