31. Income Taxes (web, sch, cfa)
The tax effects of temporary differences that give rise to deferred tax assets and liabilities are as follows ($ thousands): ===================================2007 2006 Deferred tax assets Accrued expenses: $8,613 $7,927 Tax credit and net operating loss carryforwards: 2,288 2,554 LIFO and inventory reserves: 5,286 4,327 Other: 2,664 2,109 Deferred tax assets: 18,851 16,917 Valuation allowance: (1,245) (1,360) Net deferred tax assets: $17,606 $15,557 Deferred tax liabilities: Depreciation and amortization: ($27,338) ($29,313) Compensation and retirement plans: ($3,831) ($8,963) Other: ($1,470) ($764) Deferred tax liabilities: ($32,639) ($39,040) Net deferred tax liability: ($15,033) ($23,483) 1. A reduction in the statutory tax rate would most likely benefit the company's: A. income statement and balance sheet. B. income statement but not the balance sheet. C. balance sheet but not the income statement. 2. If the valuation allowance had been the same in 2007 as it was in 2006, the company would have reported $115 higher A. net income. B. deferred tax assets. C. income tax expense. 3. Compared to the provision for income taxes in 2007, the company's cash tax payments were: A. lower. B. higher. C. the same.
1. A is correct. A lower tax rate would increase net income on the income statement, and because the company has a net deferred tax liability, the net liability position on the balance sheet would also improve (be smaller). 2. C is correct The reduction in the valuation allowance resulted in a corresponding reduction in the income tax provision. 3. B is correct. The net deferred tax liability was smaller in 2007 than it was in 2006, indicating that in addition to meeting the tax payments provided for in 2007 the company also paid taxes that had been deferred in prior periods.
The components of earnings before income taxes are as follows ($ thousands): Earnings before income taxes======2007 2006 2005 United States: =============$88,157 $75,658 $59,973 Foreign: ===============$116,704 $113,509 $94,760 Total =================$204,861 $189,167 $154,733 The components of the provision for income taxes are as follow's ($ thousands): Income taxes===============2007 2006 2005 Current Federal: ==================$30,632 $22,031 $18,959 Foreign: ==================$28,140 $27,961 $22,263 Total: ====================$58,772 $49,992 $41,222 Deferred: Federal: ==================($4,752) $5,138 $2,336 Foreign: ==================$124 $1,730 $621 Total: ====================($4,628) $6,868 $2,957 Grand Total: ==============$54,144 $56,860 $44,179 1. In 2007, the company's US GAAP income statement recorded a provision for income taxes closest to: A. $30,632. B. $54,144. C. $58,772. 2. The company's effective tax rate was highest in: A. 2005. B. 2006. C. 2007 3. Compared to the company's effective tax rate on US income;, its effective tax rate on foreign income was: A. lower in each year presented. B. higher in each year presented. C. higher in some periods and lower in others.
1. B is correct. The income tax provision in 2007 was $54,144, consisting of $58,772 in current income taxes, of which $4,628 were deferred. 2. B is correct The effective tax rate of 30.1 percent ($56,860/$189,167) was higher than the effective rates in 2005 and 2007. 3. A is correct. In 2007 the effective tax rate on foreign operations was 24.2 percent [($28,140 + $124)/$116,704] and the effective US tax rate was [($30,632 — $4,752)/$88,157] = 29.4 percent In 2006 the effective tax rate on foreign operations was 26.2 percent and the US rate was 35.9 percent. In 2005 the foreign rate was 24.1 percent and the US rate was 35.5 percent.
A company's provision for income taxes resulted in effective tax rates attributable to loss from continuing operations before cumulative effect of change in accounting principles that varied from the statutory federal income tax rate of 34 percent, as summarized in the table below. Year Ended 30 June ==============2007 =2006 =2005 Expected federal income tax expense (benefit) from continuing operations at 34 percent =($112,000) $768,000 $685,000 Expenses not deductible for income tax purposes = 357,000 32,000 51,000 State income taxes, net of federal benefit =132,000 22,000 100,000 Change in valuation allowance for deferred tax assets =(150,000) (766,000) (754,000) Income tax expense =$227,000 $56,000 $82,000 1. In 2007, the company's net income (loss) was closest to: A. ($217,000). B. ($329,000). C. ($556,000). 2. The $357,000 adjustment in 2007 most likely resulted in: A. an increase in deferred tax assets. B. an increase in deferred tax liabilities. C. no change to deferred tax assets and liabilities. 3. Over the three years presented, changes in the valuation allowance for deferred tax assets were most likely indicative of: A. decreased prospect for future profitability. B. increased prospects for future profitability. C. assets being carried at a higher value than their tax base.
1. C is correct. The income tax provision at the statutory rate of 34 percent is a benefit of $112,000, suggesting that the pre-tax income was a loss of$112,000/0.34 = ($329,412). The income tax provision was $227,000. ($329,412)- $227,000 = ($556,412) 2. C is correct. Accounting expenses that are not deductible for tax purposes result in a permanent difference, and thus do not give rise to deferred taxes. 3. B is correct. Over the three-year period, changes in the valuation allowance reduced cumulative income taxes by $1,670,000. The reductions to the valuation allowance were a result of the company being "more likely than not" to earn sufficient taxable income to offset the deferred tax assets.
• A firm acquires an asset for $120,000 with a 4-year useful life and no salvage value. • The asset will generate $50,000 of cash flow for all four years. • The tax rate is 40% each year. • The firm will depreciate the asset over three years on a straight-line (SL) basis for tax purposes and over four years on a SL basis for financial reporting purposes. Taxable income in year 1 is: A. $6,000. B. $10,000. C. $20,000. Taxes payable in year 1 are: A. $4,000. B. $6,000. C. $8,000. Pretax income in year 4 is: A. $6,000. B. $10,000. C. $20,000. Income tax expense in year 4 is: A. $4,000. B. $6,000. C. $8,000. Taxes payable in year 4 are: A. $4,000. B. $6,000. C. $20,000. At the end of year 2, the firm's balance sheet will report a deferred tax: A. asset of$4,000. B. asset of$8,000. C. liability of $8,000. Suppose tax rates rise during year 2 to 50%. At the end of year 2, the firm's balance sheet will show a deferred tax liability of: A. $5,000. B. $6,000. C. $10,000.
3. B Annual depreciation expense for tax purposes is ($120,000 cost- $0 salvage value) / 3 years = $40,000. Taxable income is $50,000- $40,000 = $10,000. 4. A Taxes payable is taxable income x tax rate = $10,000 x 40% = $4,000. (The $10,000 was calculated in question #3.) 5. C Annual depreciation expense for financial purposes is ($120,000 cost- $0 salvage value) / 4 years = $30,000. Pretax income is $50,000 - $30,000 = $20,000. 6. C Because there has been no change in the tax rate, income tax expense is pretax income x tax rate = $20,000 x 40% = $8,000. (The $20,000 was calculated in question #5.) 7. C Note that the asset was fully depreciated for tax purposes after year 3, so taxable income is $50,000. Taxes payable for year 4 = taxable income x tax rate = $50,000 x 40% = $20,000. 8. C At the end of year 2, the tax base is $40,000 ($120,000 cost — $80,000 accumulated tax depreciation) and the carrying value is $60,000 ($120,000 cost- $60,000 accumulated financial depreciation). Since the carrying value exceeds the tax base, a DTL of $8,000 [($60,000 carrying value- $40,000 tax base) x 40%] is reported. 9. C The deferred tax liability is now $10,000 [($60,000 carrying value — $40,000 tax base) x 50%].
Alter Inc. determines that it has $35,000 of accounts receivable outstanding at the end of 20X8. Based on past experience, it recognizes an allowance for bad debt equal to 10% of its credit sales. The tax base of Alter's accounts receivable at the end of 20X8 is closest to: A) $35,000. B) $31,500. C) $3,500.
A For tax purposes, bad debt expense cannot be deducted until the receivables are deemed worthless. Therefore, the tax base is $35,000 since no bad debt expense has been deducted on the tax return. Note that the carrying value would be $31,500 since bad debt expense is reflected on the income statement.
A company purchased a new pizza oven directly from Italy for $12,675. It will work for 5 years and has no salvage value. The tax rate is 41%, and annual revenues are constant at $7,192. For financial reporting, the straight-line depreciation method is used, but for tax purposes depreciation is accelerated to 35% in years 1 and 2, and 30% in year 3. For purposes of this exercise ignore all expenses other than depreciation. Assume the tax rate for years 4 and 5 changed from 41% to 31%. What will be the deferred tax liability as of the end of year 3 and the resulting adjustment to net income in year 3 for financial reporting purposes due to the change in the tax rate? Deferred Tax Liability =====Net Income A) $1,572 ===============$507 B) $1,572 ===============$747 C) $1,039 ===============$507
A Straight-line depreciation is $12,675 / 5 = $2,535. Financial statement income is $7,192 ? $2,535 = $4,657. Accelerated depreciation is $12,675(0.35) = $4,436 in years 1 and 2 and $12,675(0.3) = $3,803 in year 3. Taxable income is $7,192 ? $4,436 = $2,756 in years 1 and 2 and $7,192 ? $3,803 = $3,389 in year 3. At the old tax rate of 41%: Deferred Tax liability for year 1 = $779.41 [($4,657 ? $2,756)(0.41)] Deferred Tax liability for year 2 = $779.41 [($4,657 ? $2,756)(0.41)] Deferred Tax liability for year 3 = $519.88 [($4,657 ? $3,389)(0.41)] Deferred tax liability at the end of year 3, before the change in tax rate, is $2,079 = ($779.41 + $779.41 + $519.88) At the new tax rate of 31%: Deferred Tax liability for year 1 = $589.31 [($4,657 ? $2,756)(0.31)] Deferred Tax liability for year 2 = $589.31 [($4,657 ? $2,756)(0.31)] Deferred Tax liability for year 3 = $393.08 [($4,657 ? $3,389)(0.31)] Deferred tax liability at the end of year 3, after the change in tax rate, will be $1,572 = ($589.31 + $589.31 + $393.08) The deferred tax liability will decrease by $507 = ($2,079 ? $1,572) due to the new lower tax rate. An adjustment of $507 in tax expense will result in increase in net income by the same amount $507. Another way of answering this question is as follows: The deferred tax liability is the cost of the oven multiplied by the difference in the amount of depreciation at the end of year 3 between accelerated depreciation (100%) and straight line (60%) depreciation methods multiplied by the tax rate ((12,675 × 0.4) × 0.31 = $1,572). The change in net income due to the change in tax rates is the cost of the oven multiplied by the difference in the amount of depreciation at the end of year 3 multiplied by the difference in tax rates (12,675 × 0.4 × (0.41 ? 0.31) = 507).
Christophe Inc. is an electronics manufacturing firm. It owns equipment with a tax basis of $800,000 and a carrying value of $600,000 as the result an impairment charge. It also has a tax loss carryforward of $300,000 that is expected to be utilized within the next year or two. The tax rate on these items is 40% but the tax rate is expected to decrease to 35% for the foreseeable future. Which of the following amounts is closest to the net effect of the change in tax rate on the income statement? A) Increase in deferred tax expense of $25,000. B) Increase in deferred tax expense of $5,000. C) Decrease in deferred tax expense of $5,000.
A The $200,000 difference between the tax base and the carrying value of the equipment gives rise to a deductible temporary difference that leads to a deferred tax asset (DTA) of $80,000 ($200,000 × 40%). The tax loss carryforward of $300,000 also leads to a DTA but for $120,000 ($300,000 × 40%). The decrease in the tax rate from 40% to 35% will reduce the DTA of the equipment by $10,000 ($200,000 × 5%). It will reduce the DTA of the tax loss carryforward by $15,000 ($300,000 × 5%). In total, the DTA will decrease by $25,000. Therefore, the balancing entry will be to increase deferred tax expense by $25,000.
Which of the following statements regarding the disclosure of deferred taxes in a company's balance sheet is most accurate? A) Current deferred tax liability, current deferred tax asset, noncurrent deferred tax liability and noncurrent deferred tax asset are each disclosed separately. B) There should be a combined disclosure of all deferred tax assets and liablities. C) Current deferred tax liability and noncurrent deferred tax asset are netted, resulting in the disclosure of a net noncurrent deferred tax liability or asset.
A Deferred tax assets and liabilities must be separated between current and noncurrent accounts.
A firm buys an asset with an estimated useful life of five years for $100,000 at the beginning of the year. The firm will depreciate the asset on a straight-line basis with no salvage value on its financial statements and will use double declining balance depreciation for tax. The tax basis for this asset at the end of the first year is closest to: A) $60,000. B) $80,000. C) $40,000.
A For tax, the asset's basis is reduced by the DDB depreciation (2/5 × 100,000 = 40,000) from $100,000 to $60,000.
Laser Tech has net temporary differences between tax and book income resulting in a deferred tax liability of $30.6 million. According to U.S. GAAP, an increase in the tax rate would have what impact on deferred taxes and net income, respectively: Deferred Taxes Net Income A) Increase Decrease B) Increase No effect C) No effect Decrease
A If tax rates rise then deferred tax liabilities will also rise. The increase in deferred tax liabilities will increase the current tax expense, and if expenses are increasing the net income will decrease.
Which of the following statements is CORRECT? Income tax expense: A) includes taxes payable and deferred income tax expense. B) is the amount of taxes due to the government. C) is the reported net of deferred tax assets and liabilities.
A Income tax expense is defined as expense resulting from current period pretax income. It includes taxes payable and deferred income tax expense. Taxes payable are the amount of taxes due the government.
In 20X8, Oliver Ltd. received $80,000 cash from a customer for goods that it could not deliver until the next year and established a liability for unearned revenue. Oliver reports under U.S. GAAP, faces a 40% tax rate, and is located in a tax jurisdiction where unearned revenue is taxed as received. On their balance sheet for 20X8, what change in deferred tax should Oliver record as a result of this transaction? A) A deferred tax asset of $32,000. B) A deferred tax liability of $32,000. C) There is no effect on deferred tax items from this transaction.
A Oliver has paid tax on the $80,000 revenue in 20X8, but has not recorded the revenue on it for financial statement purposes. This results in a temporary difference of $32,000, which is a deferred tax asset. The tax asset will be realized when the company recognizes the revenue on its financial statements in the subsequent period.
At the end of 20X8, Martin Inc. estimates that $26,000 of warranty repairs will be required in the future on goods already sold. For tax purposes, warranty expense is not deductible until the work is actually performed. The firm believes that the warranty work will be required over the next two years. The tax base of the warranty liability at the end of 20X8 is: A) zero. B) $13,000. C) $26,000.
A The carrying value of the warranty liability is $26,000 (the same amount is recorded as a liability on the balance sheet and as an expense on the income statement). The tax base is equal to the carrying value less any amounts deductible in the future. Therefore, the tax base is $0 ($26,000 ? $26,000) since the warranty expense will be deductible when the work is performed next year.
A tax rate that has been substantively enacted is used to determine the balance sheet values of deferred tax assets and deferred tax liabilities under: A) IFRS only. B) U.S. GAAP only. C) both IFRS and U.S. GAAP.
A Under IFRS, a tax rate that has been enacted or substantively enacted is used to measure deferred tax items. Under U.S. GAAP, only a tax rate that has actually been enacted can be used.
The author of a new textbook received a $100,000 advance from the publisher this year. $40,000 of income taxes were paid on the advance when received. The textbook will not be finished until next year. Determine the tax basis of the advance at the end of this year. A. $0. B. $40,000. C. $100,000.
A For revenue received in advance, the tax base is equal to the carrying value minus any amounts that will not be taxed in the future. Since the advance has already been taxed, $100,000 will not be taxed in the future. Thus, the textbook advance liability has a tax base of $0 ($100,000 carrying value — $100,000 revenue not taxed in the future).
If the tax base of an asset exceeds the asset's carrying value and a reversal is expected in the future: A. a deferred tax asset is created. B. a deferred tax liability is created. C. neither a deferred tax asset nor a deferred tax liability is created.
A If the tax base of an asset exceeds the carrying value, a deferred tax asset is created. Taxable income will be lower in the future when the reversal occurs.
An analyst is comparing a firm to its competitors. The firm has a deferred tax liability that results from accelerated depreciation for tax purposes. The firm is expected to continue to grow in the foreseeable future. How should the liability be treated for analysis purposes? A. It should be treated as equity at its full value. B. It should be treated as a liability at its full value. C. The present value should be treated as a liability with the remainder being treated as equity.
A The DTL is not expected to reverse in the foreseeable future because a growing firm is expected to continue to increase its investment in depreciable assets, and accelerated depreciation for tax on the newly acquired assets delays the reversal of the DTL. The liability should be treated as equity at its full value.
In its first year of operations, a firm produces taxable income of-$10,000. The prevailing tax rate is 40%. The firm's balance sheet will report a deferred tax: A. asset of$4,000. B. asset of$10,000. C. liability of $4,000.
A The tax loss carryforward results in a deferred tax asset equal to the loss multiplied by the tax rate.
Deferred tax liabilities should be treated as equity when: A. they are not expected to reverse. B. the timing of tax payments is uncertain. C. the amount of tax payments is uncertain.
A is correct. If the liability will not reverse, there will be no required tax payment in the future and the "liability" should be treated as equity.
A company receives advance payments from customers that are immediately taxable but will not be recognized for accounting purposes until the company fulfills its obligation. The company will most likely record: A. a deferred tax asset. B. a deferred tax liability. C. no deferred tax asset or liability.
A is correct. The advances represent a liability for the company. The carrying value of the liability exceeds the tax base (which is now zero). A deferred tax asset arises when die carrying value of a liability exceeds its tax base.
When accounting standards require an asset to be expensed immediately but tax rules require the item to be capitalized and amortized, the company will most likely record: A. a deferred tax asset B. a deferred tax liability. C. no deferred tax asset or liability.
A is correct. The capitalization will result in an asset with a positive tax base and zero carrying value. The amortization means the difference is temporary. Because there is a temporary difference on an asset resulting in a higher tax base than carrying value, a deferred tax asset is created.
In early 2009 Sanborn Company must pay the tax authority €37,000 on the income it earned in 2008. This amount was recorded on the company's 31 December 2008 financial statements as: A. taxes payable. B. income tax expense. C. a deferred tax liability.
A is correct. The taxes a company must pay in the immediate future are taxes payable.
A tax loss carryforward is best described as the: A) net taxable loss that can be used to refund paid taxes from the previous year. B) net taxable loss that can be used to reduce taxable income in the future. C) difference of deferred tax liabilities and deferred tax assets.
B A tax loss carryforward is the net taxable loss that can be used to reduce taxable income in the future.
An analyst gathered the following information about a company: Pretax income = $10,000. Taxes payable = $2,500. Deferred taxes = $500. Tax expense = $3,000. What is the firm's reported effective tax rate? A) 25%. B) 30%. C) 5%.
B Reported effective tax rate = Income tax expense / pretax income = $3,000 / $10,000 = 30%
Which of the following best describes valuation allowance? Valuation allowance is a reserve: A) created when deferred tax assets are greater than deferred tax liabilities. B) against deferred tax assets based on the likelihood that those assets will not be realized. C) against deferred tax liabilities based on the likelihood that those liabilities will be paid.
B Valuation allowance is a reserve against deferred tax assets based on the likelihood that those assets will not be realized. Deferred tax assets reflect the difference in tax expense and taxes payable that are expected to be recovered from future operations.
Which of the following statements about deferred taxes is least accurate? Deferred taxes: A) arise primarily due to differences between GAAP and IRS code. B) can relate to either permanent or temporary differences. C) may never "reverse" in the case of companies that are growing.
B Permanent difference will not result in deferred taxes since they are not expected to reverse in the future.
A company purchased a new pizza oven directly from Italy for $12,676. It will work for 5 years and has no salvage value. The tax rate is 41%, and annual revenues are constant at $7,192. For financial reporting, the straight-line depreciation method is used, but for tax purposes depreciation is accelerated to 35% in years 1 and 2, and 30% in year 3. For purposes of this exercise ignore all expenses other than depreciation. What is the tax payable for year one? A) $1,909. B) $1,130. C) $779.
B Tax payable for year 1 will be $1,130 = [{$7,192 ? ($12,676 × 0.35)} × 0.41]
Which of the following statements about tax deferrals is NOT correct? A) A deferred tax liability is expected to result in future cash outflow. B) Taxes payable are determined by pretax income and the tax rate. C) Income tax paid can include payments or refunds for other years.
B Taxes payable are the taxes due to the government and are determined by taxable income and the tax rate. Note that pretax income is income before tax expense and is used for financial reporting. Taxable income is the income based upon IRS rules that determines taxes due and is used for tax reporting.
The difference between income tax expense and taxes payable is a: A) deferred tax liability. B) deferred income tax expense. C) timing difference.
B Taxes payable is defined as the taxes due to the government as determined by taxable income and the tax rate, while income tax expense is the amount actually recognized on the income statement. Deferred income tax expense is defined as the difference in income tax expense and taxes payable. Each individual deferred item is expected to be paid (or recovered) in future years.
Which of the following statements regarding differences in taxable and pretax income is CORRECT? Differences in taxable and pretax income that: A) increase or reduce the effective tax rate are called temporary differences. B) result in deferred taxes are called temporary differences. C) are not reversed for five or more years are called permanent differences.
B The permanent differences are never reversed, while there is no time limit on temporary differences to reverse. Permanent differences never result in tax deferrals; temporary differences always result in deferred tax assets or liabilities.
An analyst gathered the following information about a company: Taxable income = $100,000. Pretax income = $120,000. Current tax rate = 20%. Tax rate when the reversal occurs will be 10%. What is the company's tax expense? A) $24,000. B) $22,000. C) $10,000.
B Deferred tax liability = (120,000 ? 100,000) × 0.1 = 2,000 Tax expense = current tax rate × taxable income + deferred tax liability 0.2 × 100,000 + 2,000 = 22,000
KLH Company reported the following: • Gross DTA at the beginning of the year $10,500 • Gross DTA at the end of the year $11,250 • Valuation allowance at the beginning of the year $2,700 • Valuation allowance at the end of the year $3,900 Which of the following statements best describes the expected earnings of the firm? Earnings are expected to: A. increase. B. decrease. C. remain relatively stable.
B The valuation allowance account increased from $2,700 to $3,900. The most likely explanation is the future earnings are expected to decrease, thereby reducing the value of the DTA.
An analyst is reviewing a company with a large deferred tax asset on its balance sheet. She has determined that the firm has had cumulative losses for the last three years and has a large amount of inventory that can only be sold at sharply reduced prices. Which of the following adjustments should the analyst make to account for the deferred tax assets? A. Record a deferred tax liability to offset the effect of the deferred tax asset on the firm's balance sheet. B. Recognize a valuation allowance to reflect the fact that the deferred tax asset is unlikely to be realized. C. Do nothing. The difference between taxable and pretax income that caused the deferred tax asset is likely to reverse in the future.
B A valuation allowance is used to offset deferred tax assets if it is unlikely that those assets will be realized. Because the company has a history of losses and inventory that is unlikely to generate future profits, it is unlikely the company will realize its deferred tax assets in full.
An increase in the tax rate causes the balance sheet value of a deferred tax asset to: A. decrease. B. increase. C. remain unchanged.
B If tax rates increase, the balance sheet value of a deferred tax asset will also increase.
Analysts should treat deferred tax liabilities that are expected to reverse as: A. equity. B. liabilities. C. neither liabilities nor equity.
B is correct. If the liability is expected to reverse (and thus require a cash tax payment) the deferred tax represents a future liability.
A company incurs a capital expenditure that may be amortized over five years for accounting purposes, but over four years for tax purposes. The company will most likely record: A. a deferred tax asset B. a deferred tax liability. C. no deferred tax asset or liability
B is correct. The difference is temporary', and the tax base will be lower (because of more rapid amortization) than die carrying value of die asset. The result will be a deferred tax liability.
Zimt AG presents its financial statements in accordance with US GAAP. In 2007, Zimt discloses a valuation allowance of $1,101 against total deferred tax assets of $19,201. In 2006, Zimt disclosed a valuation allowance of $1,325 against total deferred tax assets of $17,325. The change in the valuation allowance likely indicates that Zimt's: A. deferred tax liabilities were reduced in 2007. B. expectations offuture earning power has increased. C. expectations of future earning power has decreased.
B is correct. The valuation allowance is taken against deferred tax assets to represent uncertainty that future taxable income will be sufficient to fully utilize the assets. By decreasing the allowance, Zimt is signaling greater likelihood that future earnings will be offset by the deferred tax asset.
Habel Inc. owns equipment with a tax base of $400,000 and a carrying value of $600,000. Habel also has a tax loss carryforward of $200,000 that is expected to be utilized in the foreseeable future. Deferred tax items on the balance sheet are valued based on a tax rate of 30%. If the tax rate is expected to increase to 35%, the adjustments to the value of deferred tax items will most likely cause Habel's total liabilities-to-equity ratio to: A) decrease. B) remain unchanged. C) increase.
C The $200,000 difference between the tax base and the carrying value of the equipment gives rise to a taxable temporary difference that leads to a deferred tax liability of $60,000 ($200,000 × 30%). The tax loss carryforward of $200,000 leads to a deferred tax asset of $60,000 ($200,000 × 30%). The increase in the tax rate from 30% to 35% will increase both the DTL and the DTA by $10,000 ($200,000 × 5%). Equity is unchanged. Therefore, the total liabilities-to-equity ratio will increase because of the increase in the deferred tax liability.
Permanent differences in taxable and pretax income: A) are reported on both tax returns and financial statements. B) can be deferred in some cases. C) are considered as changes in the effective tax rate.
C The permanent differences are never deferred but are considered increases or decreases in the effective tax rate. If the only difference between the taxable and pretax incomes were a permanent difference, then tax expense would simply be taxes payable.
While evaluating the financial statements of Omega, Inc., the analyst observes that the effective tax rate is 7% less than the statutory rate. The source of this difference is determined to be a tax holiday on a manufacturing plant located in South Africa. This item is most likely to be: A) sporadic in nature, but the effect is typically neutralized by higher home country taxes on the repatriated profits. B) continuous in nature, so the termination date is not relevant. C) sporadic in nature, and the analyst should try to identify the termination date and determine if taxes will be payable at that time.
C As the name suggests, a tax holiday is usually a temporary exemption from having to pay taxes in some tax jurisdiction. Because of the temporary nature, the key issue for the analyst is to determine when the holiday will terminate, and how the termination will affect taxes payable in the future.
If a firm overestimates its warranty expenses, which of the following results is least likely? A) A deferred tax asset will result. B) A timing difference will result between tax and financial reporting. C) Income tax expense will be greater than taxes payable.
C Income tax expense will be less than taxes payable because the firm can only recognize warranty expense as they occur. Thus, if the warranty expenses are overestimated on the financial statements income tax expense will be less that taxes payable.
Enduring Corp. operates in a country where net income from sales of goods are taxed at 40%, net gains from sales of investments are taxed at 20%, and net gains from sales of used equipment are exempt from tax. Installment sale revenues are taxed upon receipt. For the year ended December 31, 2004, Enduring recorded the following before taxes were considered: Net income from the sale of goods was $2,000,000, half was received in 2004 and half will be received in 2005. Net gains from the sale of investments were $4,000,000, of which 25% was received in 2004 and the balance will be received in the 3 following years. Net gains from the sale of equipment were $1,000,000, of which 50% was received in 2004 and 50% in 2005. On its financial statements for the year ended December 31, 2004, Enduring should apply an effective tax rate of: A) 22.86% and increase its deferred tax asset by $1,000,000. B) 26.67% and increase its deferred tax liability by $1,000,000. C) 22.86% and increase its deferred tax liability by $1,000,000.
C Total taxes eventually due on 2004 activities were (($2,000,000 × 0.40) + ($4,000,000 × 0.20) =) $1,600,000. Permanent differences are adjusted in the effective tax rate, which is ($1,600,000 / $7,000,000 =) 22.86%. Of the $1,600,000 taxes due, (($2,000,000 × 0.50 × 0.40) + ($4,000,000 × 0.25 × 0.20) =) $600,000 were paid in 2004 and $1,000,000 ($1,600,000 ? $600,000) is added to deferred tax liability.
One major difference between the presentation of deferred tax assets and liabilities under IFRS and under U.S. GAAP is that: A) a valuation allowance is presented only under U.S. GAAP. B) under IFRS deferred tax assets and liabilities are not adjusted for changes in the the firm's actual tax rate. C) all deferred tax assets and liabilities are classified as noncurrent under IFRS.
C Under U.S. GAAP, deferred tax assets and liabilities are classified as current or non-current according to the classification of the underlying asset or liability. Under IFRS, deferred tax assets and deferred tax liabilities are all classified as noncurrent, with footnote disclosure about the expected timing of reversals.
Firm 1 has a deferred tax liability and Firm 2 has a deferred tax asset. With respect to the taxes payable for each firm when these deferred tax items reverse, a decrease in the firms' tax rates will lead to: Firm 1 =====================Firm 2 A) Lower taxes payable =======Lower taxes payable B) Higher taxes payable =======Lower taxes payable C) Lower taxes payable =======Higher taxes payable
C When the expected tax rate decreases, income will be taxed at a lower rate when a DTL reverses, resulting in lower (cash) taxes payable for Firm 1. In contrast, expenses that will be tax deductible when the DTA reverses will provide less of a benefit when the tax rate is lower, resulting in higher taxes payable for Firm 2.
If a firm uses accelerated depreciation for tax purposes and straight-line depreciation for financial reporting, which of the following results is least likely? A) Income tax expense will be greater than taxes payable. B) A temporary difference will result between tax and financial reporting. C) A permanent difference will result between tax and financial reporting.
C A permanent difference between tax and financial reporting is a difference that is expected to not reverse itself. Under normal circumstances, the effects of the different depreciation methods will reverse.
According to IFRS, the deferred tax consequences of revaluing held-for-use equipment upward is reported on the balance sheet: A. as an asset. B. as a liability. C. in stockholders' equity.
C The deferred tax consequences of revaluing an asset upward under IFRS are reported in stockholders' equity.
Which one of the following statements is most accurate? Under the liability method of accounting for deferred taxes, a decrease in the tax rate at the beginning of the accounting period will: A. increase taxable income in the current period. B. increase a deferred tax asset. C. reduce a deferred tax liability.
C If the tax rate decreases, balance sheet DTL and DTA are both reduced. Taxable income is unaffected.
While reviewing a company, an analyst identifies a permanent difference between taxable income and pretax income. Which of the following statements most accurately identifies the appropriate financial statement adjustment? A. The amount of the tax implications of the difference should be added to the deferred tax liabilities. B. The present value of the amount of the tax implications of the difference should be added to the deferred tax liabilities. C. No financial statement adjustment is necessary.
C No analyst adjustment is needed. If a permanent difference between taxable income and pretax income is identifiable, the difference will be reflected in the firm's effective tax rate.
Which of the following tax definitions is least accurate? A. Taxable income is income based on the rules of the tax authorities. B. Taxes payable are the amount due to the government. C. Pretax income is income tax expense divided by one minus the statutory tax rate.
C Pretax income and income tax expense are not always linked because of temporary and permanent differences.
Which of the following statements is most accurate? The difference between taxes payable for the period and the tax expense recognized on the financial statements results from differences: A. in management control. B. between basic and diluted earnings. C. between financial and tax accounting.
C The difference between taxes payable for the period and the tax expense recognized on the financial statements results from differences between financial and tax accounting.
When accounting standards require recognition of an expense that is not permitted under tax laws, the result is a: A. deferred tax liability. B. temporary difference. C. permanent difference.
C is correct Accounting items that are not deductible for tax purposes will not be reversed and thus result in permanent differences.
Using the straight-line method of depreciation for reporting purposes and accelerated depreciation for tax purposes would most likely result in a: A. valuation allowance. B. deferred tax asset. C. temporary difference.
C is correct. Because the differences between tax and financial accounting will correct over lime, the resulting deferred tax liability, for which the expense was charged to the income statement but the tax authority has not yet been paid, will be a temporary difference. A valuation allowance would only arise if there was doubt over the company's ability to earn sufficient income in the future to require paying the tax.
Income tax expense reported on a company's income statement equals taxes payable, plus the net increase in: A. deferred tax assets and deferred tax liabilities. B. deferred tax assets, less the net increase in deferred tax liabilities. C. deferred tax liabilities, less the net increase in deferred tax assets.
C is correct. Higher reported tax expense relative to taxes paid will increase the deferred tax liability', whereas lower reported tax expense relative to taxes paid increases the deferred tax asset.
When certain expenditures result in tax credits that directly reduce taxes, the company will most likely record: A. a deferred tax asset B. a deferred tax liability. C. no deferred tax asset or liability
C is correct. Tax credits that directly reduce taxes are a permanent difference, and permanent differences do not give rise to deferred tax.
When both the timing and amount of tax payments are uncertain, analysts should treat deferred tax liabilities as: A. equity. B. liabilities. C. neither liabilities nor equity
C is correct. The deferred tax liability should be excluded from both debt and equity when both the amounts and timing of tax payments resulting from the reversals of temporary differences are uncertain.
Cinnamon, Inc. recorded a total deferred tax asset in 2007 of $12,301, offset by a $12,301 valuation allowance Cinnamon most likely: A. fully utilized the deferred tax asset in 2007. B. has an equal amount of deferred tax assets and deferred tax liabilities. C. expects not to earn any taxable income before the deferred tax asset expires.
C is correct. The valuation allowance is taken when the company will "more likely than not" fail to earn sufficient income to offset the deferred tax asset Because the valuation allowance equals the asset, by extension die company' expects no taxable income prior to the expiration of the deferred tax assets
