Reading 24: income taxes Flashcards
Which of the following tax definitions is least accurate?
Taxable income is income based on the rules of the tax authorities.
Taxes payable are the amount due to the government.
Pretax income is income tax expense divided by one minus the statutory tax rate.
Pretax income and income tax expense are not always linked because of temporary and permanent differences. (LOS 24.a)
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:
in management control.
between basic and diluted earnings.
between financial and tax accounting.
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. (LOS 24.b)
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?
It should be treated as equity at its full value.
It should be treated as a liability at its full value.
The present value should be treated as a liability with the remainder being treated as equity.
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. (LOS 24.b)
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:
$6,000.
$10,000.
$20,000.
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. (LOS 24.c)
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
Taxes payable in year 1 are:
$4,000.
$6,000.
$8,000
Taxes payable is taxable income × tax rate = $10,000 × 40% = $4,000. (The $10,000 was calculated in the previous question.) (LOS 24.c)
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
Pretax income in year 4 is:
$6,000.
$10,000.
$20,000.
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. (LOS 24.c)
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
Income tax expense in year 4 is:
$4,000.
$6,000.
$8,000.
Because there has been no change in the tax rate, income tax expense is pretax income × tax rate = $20,000 × 40% = $8,000. (The $20,000 was calculated in the previous question.) (LOS 24.c)
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
Taxes payable in year 4 are:
$4,000.
$6,000.
$20,000.
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 × tax rate = $50,000 × 40% = $20,000. (LOS 24.c)
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
At the end of year 2, the firm’s balance sheet will report a deferred tax:
asset of $4,000.
asset of $8,000.
liability of $8,000.
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) × 40%] is reported. (LOS 24.c)
If the tax base of an asset exceeds the asset’s carrying value and a reversal is expected in the future:
a deferred tax asset is created.
a deferred tax liability is created.
neither a deferred tax asset nor a deferred tax liability is created.
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. (LOS 24.d)
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 base of the advance at the end of this year.
$0.
$40,000.
$100,000.
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). (LOS 24.d)
An increase in the tax rate causes the balance sheet value of a deferred tax asset to:
decrease.
increase.
remain unchanged.
If tax rates increase, the balance sheet value of a deferred tax asset will also increase. (LOS 24.e)
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:
increase taxable income in the current period.
increase a deferred tax asset.
reduce a deferred tax liability.
If the tax rate decreases, balance sheet DTL and DTA are both reduced. Taxable income is unaffected. (LOS 24.e)
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?
The amount of the tax implications of the difference should be added to the deferred tax liabilities.
The present value of the amount of the tax implications of the difference should be added to the deferred tax liabilities.
No financial statement adjustment is necessary.
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. (LOS 24.f)
A U.S. GAAP reporting firm reports an increased valuation allowance at the end of the current period. What effect will this have on the firm’s income tax expense in the current period?
Increase.
Decrease.
No effect.
Recognizing a greater valuation allowance reduces the net value of a deferred tax asset, which increases income tax expense in the current period. (LOS 24.h)
