Assume that a company has earned income during the year, and has not yet paid any income taxes. At the end of the year, what entry, if any, should be recorded using accrual accounting to reflect the fact that the company will have to pay taxes on the income it has earned?
A) No entry is needed, since no cash payment has yet been made.
B) An entry reducing an asset, increasing an expense, and decreasing equity
C) An entry increasing a liability, increasing an expense, and decreasing equity
D) An entry decreasing a liability, increasing an expense, and reducing equity

Question

Quizplus · Accepted Answer

Accrual accounting requires recognition of expenses when they are incurred, regardless of when they are paid. Therefore, at the end of the year, the company should record an entry increasing its income tax liability (as the taxes owed are considered a liability), increasing the income tax expense to reflect the amount of taxes owed based on income earned during the year, and decreasing equity to reflect the reduction in retained earnings caused by the income tax expense. Option C is the only choice that reflects these transactions.

Assume That a Company Has Earned Income During the Year