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Flashcards in FAR 35 (2) Deck (21):
1

Shear, Inc. began operations in 2005. Included in Shear's 2005 financial statements were bad debt expenses of $1,400 and profit from an installment sale of $2,600.

For tax purposes, the bad debts will be deducted and the profit from the installment sale will be recognized in 2007. The enacted tax rates are 30% in 2005 and 25% in 2007.

Shear elected early application of FASB Statement No. 109, Accounting for Income Taxes. In its 2005 income statement, what amount should Shear report as deferred income tax expense?

$300
Deferred income tax is the net change in the deferred tax accounts for the year. Given that this is the first year of operations, the change equals the ending deferred tax balance. Deferred tax accounts are measured using the future enacted tax rates applicable in the period of reversal.

The future 2007 tax deduction for bad debt expense will cause 2007 taxable income to decrease relative to pre-tax accounting income (a deductible difference). Therefore, a deferred tax asset is recorded for $350 ($1,400 x .25) in 2005.

The future 2007 installment revenue will be taxable then and cause taxable income to increase relative to pre-tax accounting income (a taxable difference). Therefore, a deferred tax liability is recorded for $650 ($2,600 x .25) in 2005.

The net of the deferred tax asset and liability at the end of 2005 is $300 ($650 - $350). This is the amount by which total income tax expense exceeds income tax liability (current income tax expense) and therefore equals the deferred income tax expense.

2

If Pre-tax financial income is $160,000 and Taxable income is 140,000, and the tax rate is 40%, calculate the current portion of income tax expense.

The current portion of income tax expense is the tax liability for the current year, which equals the product of the tax rate and taxable income: $140,000(.40) = $56,000.

3

Taft Corp. uses the equity method to account for its 25% investment in Flame, Inc. During 2004, Taft receives dividends of $30,000 from Flame and records $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 80% dividends-received deduction.
* There are no other temporary differences.
* Enacted income tax rates are 30% for 2004 and thereafter.

Taft elected early application of FASB Statement No. 109, Accounting for Income Taxes. In its December 31, 2004 balance sheet, what amount should Taft report for deferred income tax liability?

$9,000
The deferred tax liability ending balance in this problem equals the change in the deferred tax liability for the period, because the firm adopted SFAS No. 109 this period.

The change in the deferred tax liability is the future tax effect of the amount of income from the investment that is expected to be taxable in the future, using enacted tax rates. That amount is $9,000 = .30(.20)($180,000 - $30,000).

The ($180,000 - $30,000) amount represents the total future earnings difference between tax and book accounting. The .20 represents the proportion of income that will ultimately be taxed, and the 30% is the tax rate. The final result, $9,000, is the anticipated future tax liability, based on current transactions.

4

Leer Corp.'s pre-tax income in 2005 is $100,000. The temporary differences between amounts reported in the financial statements and the tax return are as follows:

*Depreciation in the financial statements is $8,000 more than tax depreciation.
*The equity method of accounting resulted in financial statement income of $35,000. A $25,000 dividend is received during the year, which is eligible for the 80% dividends received deduction.

Leer's effective income tax rate was 30% in 2005. In its 2005 income statement, Leer should report a current provision for income taxes of

$23,400
The current provision for income taxes is the tax liability for the year: taxable income times the tax rate. Taxable income = $100,000 + $8,000 - $35,000 + .20($25,000) = $78,000. Therefore, current income tax expense (also the firm's tax liability) is $23,400 ($78,000 x .30).

The $8,000 is added to pre-tax accounting income, because the latter income amount reflects $8,000 more depreciation than should be reflected in taxable income. The $35,000 is subtracted, because it is included in pre-tax accounting income, but is not included in taxable income. Only 20% of the dividends received is taxable owing to the 80% dividends-received deduction. The equity in income of the investee is not taxable income.

5

Bart, Inc., a newly organized corporation, uses the equity method of accounting for its 30% investment in Rex Co.'s common stock. During 2005, Rex paid dividends of $300,000 and reported earnings of $900,000. In addition:

* The dividends received from Rex are eligible for the 80% dividends-received deduction.
* All the undistributed earnings of Rex will be distributed in future years.
* There are no other temporary differences.
Bart's 2005 income tax rate is 30%.
The enacted income tax rate after 2005 is 25%.

Bart elected early application of FASB Statement No. 109, Accounting for Income Taxes. In Bart's December 31, 2005 balance sheet, the deferred income tax liability should be

$9,000
The deferred tax liability is the future enacted tax rate, multiplied by the future taxable temporary difference.

The future temporary difference is the amount of income from the investment, based on Rex's earnings through 2005 only, that is expected to be taxable in the future, using enacted tax rates. No additional income for financial-accounting purposes will be recognized on Rex's 2005 income, because the equity method has recognized Bart's entire share in 2005. The future temporary difference is (.20)(.30)($900,000 - $300,000).

Rex has paid $300,000 dividends so far and will pay the remaining $600,000 in the future. Bart's share is 30%, and only 20% will be taxed, owing to the dividends-received deduction. Multiplying that future temporary difference by the future tax rate of .25 yields the ending deferred tax liability of $9,000 = .25(.20)(.30)($900,000 - $300,000). The future tax rate is used, because that is the rate applicable when the difference reverses.

6

Fern Co. has net income, before taxes, of $200,000, including $20,000 interest revenue from municipal bonds and $10,000 paid for officers' life insurance premiums where the company is the beneficiary. The tax rate for the current year is 30%. What is Fern's effective tax rate?

28.5%
The effective tax rate is the ratio of income tax expense to pre-tax accounting income. income tax expense equals income tax liability in this case, because there are no temporary differences. Both the interest revenue and life-insurance premiums are permanent differences. The income tax liability is the product of the income tax rate and taxable income. Taxable income is $190,000 ($200,000 - $20,000 non-taxable interest included in the $200,000 + $10,000 non-deductible insurance premiums subtracted from $200,000). The income tax liability (and income tax expense) equal $57,000 (.30 x $190,000). The effective tax rate is .285 ($57,000/$200,000).

7

Tara Corp. uses the equity method of accounting for its 40% investment in Flax, Inc.'s common stock. During 2005, Flax reports earnings of $750,000 and pays dividends of $250,000.
Assume that:

* All the undistributed earnings of Flax will be distributed as dividends in future periods.
* The dividends received from Flax are eligible for the 80% dividends-received deduction.
* There are no other temporary differences.
* Tara's 2005 income tax rate is 30%.
* Enacted income tax rates after 2005 are 25%.

Tara elected early application of FASB Statement No. 109, Accounting for Income Taxes. In its December 31, 2005 balance sheet, the increase in the deferred income tax liability from the above transactions would be

$10,000
The deferred tax liability ending balance in this problem equals the change in the deferred tax liability for the period, because the firm adopted SFAS No. 109 in this period.

The change in the deferred tax liability is the future tax effect of the amount of income from the investment that is expected to be taxable in the future, using enacted tax rates. That amount is $10,000 = .25(.20)(.40)($750,000 - $250,000).

The ($750,000 - $250,000) amount represents the total future earnings difference between tax and book accounting. The .20 represents the proportion of income that will ultimately be taxed, and the .25 is the future enacted tax rate. The .40 is the proportion ownership. The final result, $10,000, is the anticipated future tax liability, based on current transactions.

8

T/F: Depreciation differences should always be treated as taxable differences if the firm uses straight-line depreciation and MACRS for taxes.

True

9

T/F: Net income equals pretax accounting income less the current provision for income taxes.

False.
Net income equals pretax accounting income less total income tax expense.

10

T/F: When there are permanent differences, the effective tax rate and the legal tax rate are the same.

False.
The future and current tax rates are the same if Congress has not enacted a new rate for future years by the end of the current year.

11

T/F: Data for the tax accrual entry: beginning deferred tax asset $4, ending deferred tax asset $7, beginning deferred tax liability $9, ending deferred tax liability $4, current provision for income tax $20. Income tax expense is $12.

True
...

12

T/F: The effective tax rate is the ratio of income tax expense to pretax accounting income.

True

13

T/F: Future estimated tax rates are used to measure the ending deferred tax accounts.

False.
Future estimated tax rates are used to calculate future deferred taxes.

14

T/F: Taxable income is $60,000. The current tax rate is 30%, and the future enacted rate is 40%. The firm has a future deductible difference of $10,000. Income tax expense is $14,000.

True
...

15

T/F: A fine lowers the effective tax rate.

False.
...

16

T/F: In two of the years in the schedule of future depreciation, tax depreciation exceeds book depreciation. The differences in these years should be treated as future deductible differences.

False.
should be treated as future taxable differences.

17

T/F: A nontaxable revenue lowers the effective tax rate.

True

18

On January 1, 2003, Warren Co. purchased a $600,000 machine, with a five-year useful life and no salvage value.

The machine was depreciated by an accelerated method for book and tax purposes. The machine's carrying amount was $240,000 on December 31, 2004. On January 1, 2005, Warren changed retroactively to the straight-line method for financial-statement purposes. Warren can justify the change. Warren's income tax rate is 30%.

On January 1, 2005, what amount should Warren report as deferred income tax liability as a result of the change?

$0
Changes in depreciation method are treated prospectively. Prior-year depreciation amounts are unchanged. Therefore, as of the beginning of the year of change, no future temporary difference is generated. But starting at the end of the year of change, a deferred tax liability will be recorded for the future difference between book and tax depreciation, now that the methods are different for those reporting systems.

19

On January 2, 2004, Ross Co. purchases a machine for $70,000. This machine has a five-year useful life, a residual value of $10,000, and is depreciated using the straight-line method for financial-statement purposes.

For tax purposes, depreciation expense was $25,000 for 2004 and $20,000 for 2005. Ross elected early application of FASB Statement No. 109, Accounting for Income Taxes. Ross' 2005 income, before income tax and depreciation expense, was $100,000 and its tax rate was 30%.

If Ross had made no estimated tax payments during 2005, what amount of current income tax liability would Ross report in its December 31, 2005 balance sheet?

$24,000
The $24,000 current tax liability is the current tax rate times taxable income: $24,000 = .30($100,000 - $20,000).

20

T/F: An increase in a deferred tax asset requires a debit to that account.

True

21

T/F: The required ending balance in the deferred tax liability equals the change in the deferred tax liability for the period.

False
The required ending balance in the deferred tax liability is based only on future taxable differences.

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