Answer:
The Answer is explanatory so it is given as under:
Explanation:
<u>Part 1. At the start of the year:</u>
The part of the salary includes $150,000 per year for the next 10 years and this must be recorded as an deferred compensation liability. All we have to do is to calculate the present value of the annual salary payments.
Present Value = Annual Payment * Annuity factor
And for Annuity factor we will use 5% rate of interest.
So
Annuity Factor = (1 - (1-r)^n) / r
Here
r = 5%
n = 10 years
Which means
Annuity Factor = (1 - (1 + 5%)^10) / 5% = 7.722
Hence
Present value = $150,000 * 7.722 = $1,158,260
So the journal entry would be as under:
Dr Deferred Compensation expense $1,158,260
Cr Deferred Compensation Liability $1,158,260
<u>Part 2. At the end of the Year 1:</u>
At the first year end, the annual payment of $1,158,260 will be discounted back by using the following formula:
Discounted Back Amount = Annual Amount * (1- (1+r)^n)
Remember for the first year n is 10, for second n is 9 and so on.
Discounted Back Amount = 150,000 x (1 - 0.614) = $57,913
Dr Deferred Compensation Expense $57,913
Cr Deferred Compensation Liability $57,913
Part 3. And when the first payment of the salary is made, the journal entry would be:
Dr Deferred compensation Liability $ 150,000
Cr Cash Account $150,000
Likewise we will till the year 10 and will record the part 2 and part 3 until at the end of the year 10, the whole of the deferred tax liability is reduced to zero.
The life insurance policy payments can not be offset against the deferred compensation liability because it will be accounted for as a different transaction and hence must not be treated as Riley desires.
So the Cash surrender value will be treated as an asset and annual increase in this asset would be treated as an income.
