FAR 36 - Income Taxes 2 - Deferred Tax Accounts/Valuation Allowance/Uncertainty Flashcards Preview

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Flashcards in FAR 36 - Income Taxes 2 - Deferred Tax Accounts/Valuation Allowance/Uncertainty Deck (24):
1

Because Jab Co. uses different methods to depreciate equipment for financial statement and income tax purposes, Jab has temporary differences that will reverse during the next year and add to taxable income.

Deferred income taxes that are based on these temporary differences should be classified in Jab's balance sheet as a
A. Contra account to current assets.
B. Contra account to non-current assets.
C. Current liability.
D. Non-current liability.

D. The classification of deferred tax accounts is the same as the accounts giving rise to the deferred taxes.

The temporary differences referred to in the question are future taxable differences, which cause a deferred tax liability. The account giving rise to the difference is equipment, which is classified as long-term.
Therefore, the deferred tax liability is also classified as long-term (non-current).

2

Hut Co. has temporary taxable differences that will reverse during the next year and add to taxable income. These differences relate to non-current assets. Deferred income taxes based on these temporary differences should be classified in Hut's balance sheet as a
A. Current asset.
B. Non-current asset.
C. Current liability.
D. Non-current liability.

D. Future taxable differences cause taxable income in the future to exceed pre-tax accounting income. Therefore, deferred tax liabilities are the result of taxable differences. Classification of deferred tax accounts is based on the item giving rise to the temporary differences. In this case, the underlying item is non-current. Therefore, the deferred tax liability is also classified as non-current.

3

In its first four years of operations ending December 31, 2002, Alder, Inc.'s depreciation for income tax purposes exceeds its depreciation for financial-statement purposes. This temporary difference is expected to reverse in 2003, 2004, and 2005. Alder had no other temporary difference and elected early adoption of FASB 109.

Alder's 2002 balance sheet should include
A. A non-current contra asset for the effects of the difference between asset bases for financial-statement and income tax purposes.
B. Both current and non-current deferred tax assets.
C. A current deferred tax liability only.
D. A non-current deferred tax liability only.

D. The classification of deferred tax accounts is based on the classification of the underlying account giving rise to the deferred tax effect.

In this case, depreciable assets are non-current assets, therefore the deferred tax account is also classified as non-current. Because the future temporary differences are taxable (future tax depreciation will be less than book depreciation, causing future taxable income to exceed pre-tax accounting income), the deferred tax account is a liability. Future taxable temporary differences give rise to deferred tax liabilities.

4

T/F: At most, there are four classifications of deferred tax accounts for internal purposes.

True
Current Asset, Current Liab.
Non-current asset, Non-currant Liab.

5

T/F: The deferred tax liability relating to a depreciable plant asset is classified noncurrent.

True

6

T/F: In deferred tax accounts, for balance sheet reporting purposes, current items are netted, and noncurrent items are netted.

True

7

T/F: The deferred tax liability relating to a depreciable plant asset is classified current if the asset has only one year remaining in its useful life at the balance sheet date.

False.
Plant assets are classified as long term, and can not change to short term, therefore any related tax liability would be classified as non-current.

8

T/F: The classification of a deferred tax account is usually based on the underlying account giving rise to the deferred tax effect.

True

9

T/F: Future deductible and taxable differences are merged to form a single deferred tax account at the end of the period.

False.
Current and non-current amounts are never netted together in the BS.

10

T/F: At most, there are four classifications of deferred tax accounts for external purposes.

False.
There is only current and non-current for FS purposes. Either as a liability or an asset, not both for each classification.

11

On its December 31, 2005 balance sheet, Shin Co. has income tax payable of $13,000 and a current deferred tax asset of $20,000, before determining the need for a valuation account.

Shin had reported a current deferred tax asset of $15,000 at December 31, 2004. No estimated tax payments are made during 2005. At December 31, 2005, Shin determines that it is more likely than not that 10% of the deferred tax asset would not be realized.

In its 2005 income statement, what amount should Shin report as total income tax expense?

$10,000
income tax expense is the net sum of the income tax liability for the year, the changes in the deferred tax accounts, and the change in the valuation account for deferred tax assets.

Tax liability (current portion of income tax expense): $13,000
Less increase in deferred tax asset: $20,000 - $15,000
($5,000)
Plus increase in valuation account: .10($20,000)
$2,000
Equals income tax expense
$10,000

The increase in the deferred tax asset causes income tax expense to decrease relative to the tax liability, because, as a result of transactions through the end of the current year, future taxable income will be reduced. This reduction is not realized in the current year as a reduction in the tax liability. Therefore, the anticipated future reduction is treated as an asset at the end of the current period. When realized, the asset is reduced in a future year.
The increase in the valuation allowance, which is contra to the deferred tax asset, reduces the deferred-tax-asset effect, because it is an amount of the deferred tax asset not likely to be realized.

12

T/F: It is Year 6. A future deductible difference is expected to reverse in Year 11. A future taxable difference is expected to reverse in Year 7. The latter difference can be used as a source of support for the realization of the deferred tax asset.

False.
A future deductible difference that is classified as non-current, would not relate to a future deductible difference that is classified as current.

13

T/F: Realization of a deferred tax asset means that the deferred tax asset is credited in the future rather than income taxes payable of an equivalent amount.

True

14

T/F: An existing sales backlog would tend to support the reporting of a deferred tax asset with a valuation allowance.

False.
The sales backlog will produce more than enough taxable income to realize the deferred tax asset, suggesting that a valuation account is not needed.

15

T/F: A deferred tax asset with better than 50% chance of being realized needs no valuation allowance.

True

16

T/F: When using prior taxable income as the source of support for a deferred tax asset, a deductible difference can be carried back 3 years.

False.
2- year carryback period for net operating losses (NOL)

17

T/F: It is Year 6. A future deductible difference is expected to reverse in Year 11. A future taxable difference is expected to reverse in Year 16. The latter difference can be used as a source of support for the realization of the deferred tax asset.

True

18

T/F: Expected future taxable income is the most common support for the expectation that a deferred tax asset will be realized.

True

19

T/F: The deductible difference is $10,000. Only $7,000 is supported by acceptable sources. The valuation allowance to be recorded will be the future tax rate times $ 3,000.

True

20

At the end of the current year, Swen Inc. prepares its tax return, which reflects an uncertain amount, reducing the firm's tax liability by $40,000. Swen estimates that, upon audit by the IRS, there is a 20% chance that the full $40,000 benefit will be upheld, and a 40% chance that the benefit will be only $25,000. As a result of the required recognition and measurement principles for uncertain tax positions, current-year income tax expense is reduced by what amount?
A. $18,000
B. $25,000
C. $40,000
D. $15,000

B. This is the largest amount, which has at least a 50% probability of occurring. The cumulative probability through this amount is 60%. A liability is recognized for the $15,000 of the total $40,000, which has less than a 50% chance of occurring.

21

Two years ago, Aggre Inc. recognized the tax benefit of an uncertain tax position. income tax expense in that year was reduced by $20,000 as a result. In addition, Aggre recorded a $5,000 tax liability for unrecognized benefits for the same tax position. During the current year, the uncertainty is resolved and a benefit of $22,000 is upheld. By what amount is current-year income tax expense affected by the resolution of the prior uncertainty?
A. $2,000 decrease.
B. $22,000 decrease.
C. $5,000 decrease.
D. There is no effect.

A. Income tax expense was reduced two years ago by $20,000, but the final benefit upon resolution is $22,000. The $2,000 increase in benefit is recognized in the year of resolution.

22

T/F: For an uncertain tax benefit, management is able to estimate only one outcome. A probability of 65% is ascribed to that outcome. Income tax expense is reduced by 100% of the benefit amount.

False.
It's only reduced up to the 65%, while the remainder is not allowed a deduction

23

T/F: If an uncertain tax position affecting a firm's current year tax return has less than a 50% chance of being upheld, income tax expense for the current year is not reduced by any amount related to the uncertain tax position.

True

24

T/F: A firm which includes an uncertain tax deduction in its tax return will most likely report a tax-related liability in addition to income tax payable.

True

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