Accounting for Income Taxes Flashcards
(10 cards)
In its Year 1 income statement, Tow, Inc. reported proceeds from an officer’s life insurance policy of $90,000 and depreciation of $250,000. Tow was the owner and beneficiary of the life insurance on its officer. Tow deducted depreciation of $370,000 in its Year 1 income tax return when the tax rate was 30%. Data related to the reversal of the excess tax deduction for depreciation follow:
Year Reversal of excess
tax deduction Enacted
tax rates
Year 2 $50,000 35%
Year 3 $40,000 35%
Year 4 $20,000 25%
Year 5 $10,000 25%
There are no other temporary differences. In its December 31, Year 1, balance sheet, what amount should Tow report as a deferred income tax liability?
A. $36,000
B. $39,000
C. $63,000
D. $66,000
B. $39,000
Sum of numbers multiplied by percentages.
Which of the following statements is correct regarding valuation allowances in accounting for income taxes?
A. A change in the balance of a valuation allowance is ordinarily included in net income.
B. Both deferred tax assets and deferred tax liabilities can be reduced by a valuation allowance.
C. Only negative evidence, not positive evidence, should be considered when determining whether a valuation allowance is needed.
D. A valuation allowance is necessary when the reasonably possible standard of evidence is satisfied.
A. A change in the balance of a valuation allowance is ordinarily included in net income.
A deferred tax asset (DTA) represents future taxes saved on the balance sheet as a result of temporary book-tax differences that will reduce future taxable income (TI). If it is “more likely than not” (ie, > 50% likelihood) that a DTA will not be realized, a valuation allowance (contra-asset) is established to offset the realizable asset (Choice D). The allowance is based on all available evidence (both positive and negative) that supports the determination that the DTA will not be realized (Choice C).
A valuation account for a DTL is not permitted.
Selion Co. has financial net income, before taxes, of $835,000, including the following:
Insurance proceeds (paid by reason of death) from a policy on a corporate officer (no corresponding premiums were paid during the year) $250,000
Environmental fines 93,000
The statutory enacted tax rate for the current year is 25%. What is Selion’s effective tax rate for the current year?
A. 17.5%
B. 19.8%
C. 20.3%
D. 27.8%
C. 20.3%
835000-250000+93000 = 678,000
678,000 * .25 = 169,500
169,500/835000 = 20.3%
Tower Corp. began operations on January 1, Year 1. For financial reporting, Tower recognizes revenues from all sales under the accrual method. However, in its income tax returns, Tower reports qualifying sales under the installment method. Tower’s gross profit on these installment sales under each method was as follows:
Year Accrual method Installment method
Year 1 $1,600,000 $600,000
Year 2 $2,600,000 $1,400,000
The income tax rate is 30% for Year 1 and future years. There are no other temporary or permanent differences. In its December 31, Year 2, balance sheet, what amount should Tower report as a liability for deferred income taxes?
A. $360,000
B. $600,000
C. $660,000
D. $840,000
C. $660,000
You assume that year 1 did not reverse so it is added to year 2.
In this scenario, no information about the reversal of any of Tower Corp.’s Year 1 DTL is provided; therefore, the full amount remains on the balance sheet. The DTL at December 31, Year 2, is $660,000, calculated as follows:
Year 1 DTL ($1,600,000 − $600,000) × 30% $300,000
Year 2 DTL ($2,600,000 − $1,400,000) × 30% 360,000
Cumulative DTL at December 31, Year 2 $660,000
Taft Corp. uses the equity method to account for its 25% investment in Flame, Inc. During Year 3, Taft received dividends of $30,000 from Flame and recorded $180,000 as its equity in the earnings of Flame. Additional information follows:
All the undistributed earnings of Flame will be distributed as dividends in future periods.
The dividends received from Flame are eligible for the 65% dividends received deduction.
There are no other temporary differences.
Enacted income tax rates are 30% for Year 3 and thereafter.
In its December 31, Year 3, balance sheet, what amount should Taft report for deferred income tax liability?
A. $15,750
B. $29,250
C. $18,900
D. $54,000
A. $15,750
In this scenario, the $180,000 of equity in earnings is not currently taxable, but the $30,000 of dividends is. This creates a temporary difference of $150,000. However, since this amount is expected to be received as future dividends, it will be eligible for the 65% DRD, which creates a permanent difference. Taft Corp.’s DTL of $15,750 is based on the net temporary difference (ie, net future taxable dividends).
Temporary timing difference
($180,000 earnings − $30,000 dividends) $150,000
Less: permanent difference for 65% DRD
($150,000 × 65% = $97,500) (97,500)
Net temporary difference $52,500
Tax rate × 30%
DTL $15,750
A publicly traded corporation reported a $10,000 deduction in its current-year tax return for an item it expects to be disallowed. The tax rate is 40%. How should the corporation report this tax position in the financial statements?
A. As a temporary difference disclosed in the notes to the financial statements that is not recognized.
B. As a $10,000 deferred tax asset.
C. As a $4,000 income tax expense and a $4,000 liability for an unrecognized tax benefit.
D. As a $4,000 deferred tax asset and a $4,000 income tax benefit.
C. As a $4,000 income tax expense and a $4,000 liability for an unrecognized tax benefit.
A tax position is a position previously taken on a filed tax return (or expected to be taken on a future tax return) that is reflected in determining current or deferred income tax assets and liabilities. An entity may take uncertain tax positions (UTP) related to deductions, credits, or income that have not yet been resolved through an audit or litigation.
The tax benefit from a UTP may be recognized or unrecognized on the financial statements.
An unrecognized tax benefit is reported as a liability representing the potential income taxes a company might have to pay in the future due to the UTP.
A tax benefit can only be recognized if there is a more-likely-than-not (greater than 50%) chance the tax position will be sustained (allowed) when examined by the federal or state tax authorities.
If the UTP does not have a more-likely-than-not chance of being sustained, a liability for the unrecognized tax benefit should be recorded for any potential future taxes owed. The unrecognized tax benefit can be realized when the tax position is settled.
Here, since the corporation expects the deduction will be disallowed, the more-likely-than-not threshold is not met, and no tax benefit is recognized (Choice D). However, a liability for the unrecognized tax benefit and tax expense is recorded. Assuming the entire deduction will be disallowed, an additional $4,000 ($10,000 × 40%) of income tax expense will be recorded in the income statement and a corresponding $4,000 unrecognized tax benefit liability will be recorded on the balance sheet.
Bart, Inc., a newly organized corporation, uses the equity method of accounting for its 30% investment in Rex Co.’s common stock. During Year 1, Rex paid dividends of $300,000 and reported earnings of $900,000. In addition:
The dividends received from Rex are eligible for the 65% dividends received deduction.
All the undistributed earnings of Rex will be distributed in future years.
There are no other temporary differences.
Bart’s Year 1 income tax rate is 30%. The enacted income tax rate after Year 1 is 21%.
In Bart’s December 31, Year 1, balance sheet, the deferred income tax liability should be
A. $13,230
B. $18,900
C. $24,570
D. $37,800
A. $13,230
In this scenario, Bart Inc.’s portion (30%) of Rex Co.’s earnings and dividends must be calculated.
The $270,000 ($900,000 × 30%) of investee earnings are not currently taxable but the $90,000 ($300,000 × 30%) of dividends are. The excess investee earnings create a temporary difference of $180,000.
Since the excess is expected to be received as future dividends, it will be eligible for the 65% DRD, creating a permanent difference.
Bart’s DTL of $13,230 is based on the net temporary difference using the 21% future enacted rate.
Temporary timing difference
($270,000 − $90,000) $180,000
Less: permanent difference for 65% DRD
($180,000 × 65% = $117,000) (117,000)
Net temporary difference
(net future taxable dividends) $63,000
Future tax rate × 21%
DTL $13,230
A company reported the following financial information:
Taxable income for current year $120,000
Deferred income tax liability, beginning of year 50,000
Deferred income tax liability, end of year 55,000
Deferred income tax asset, beginning of year 10,000
Deferred income tax asset, end of year 16,000
Current and future years’ tax rate 35%
The income tax expense for the current year is what amount?
A. $41,000
B. $42,000
C. $43,000
D. $53,000
A. $41,000
Tax benefit lowers tax expense, but only in the JE
Tax Expense (debit) - 41,000
Deferred Tax Benefite (debit) - 1,000
Tax Payable (credit) 42,000
Leer Corp.’s pretax income in Year 1 was $100,000. The differences between amounts reported in the financial statements and the tax return are as follows:
Depreciation in the financial statements was $8,000 more than tax depreciation.
The equity method of accounting resulted in financial statement income of $35,000 from the investee.
A $25,000 dividend was received during the year from the investee, which is eligible for the 65% dividends received deduction.
Leer’s effective income tax rate was 30% in Year 1. In its Year 1 income statement, Leer should report a current income tax expense of
A. $19,725
B. $22,125
C. $24,525
D. $25,725
In this scenario, Leer Corp.’s pretax income must be adjusted for the permanent and temporary differences created by the excess depreciation expense and the equity method.
Pretax book income $100,000
Temporary differences
Add excess depreciation reported on the books 8,000
Add actual dividends received 25,000
Deduct income reported due to the equity method (35,000)
Permanent difference
Deduct DRD allowed for tax only ($25,000 × 65%) (16,250)
Taxable income $81,750
Therefore, Leer should report a current tax expense of $24,525 ($81,750 × 30% effective tax rate).
As a result of differences between depreciation for financial reporting purposes and tax purposes, the financial reporting basis of a company’s plant assets exceeded the tax basis. Assuming the company had no other temporary differences, the company should report a
A. Current tax receivable.
B. Current tax payable.
C. Deferred tax asset.
D. Deferred tax liability.
D. Deferred tax liability.
This is confusing, but the question is saying that tax depreciation will be higher than financial depreciation which caused a DTL.
