Chapter 16Income Taxes

MULTIPLE CHOICE
1. Which of the following creates a permanent difference between financial income and taxable
income?
a. Interest received on municipal bonds
b. Completed contract method of recognizing construction revenue
c. Unearned rent revenue
d. Accelerated cost recovery on plant and equipment
ANS: A

OBJ: LO 1

2. Which of the following creates a temporary difference between financial and taxable income?
a. Interest on municipal bonds
b. Accelerated cost recovery on plant and equipment
c. Fines from violation of law
d. Premiums paid for officer's life insurance (company is beneficiary)
ANS: B

OBJ: LO 1

3. The purpose of an interperiod income tax allocation is to

a. allow reporting entities to fully utilize tax losses carried forward from a previous year.
b. allow reporting entities whose tax liabilities vary significantly from year to year to smooth
payments to taxing agencies.
c. recognize an asset or liability for the tax consequences of temporary differences that exist
at the balance sheet date.
d. amortize the deferred tax liability shown on the balance sheet.
ANS: C

OBJ: LO 1

4. The result of interperiod income tax allocation is that

a. wide fluctuations in a company's tax liability payments are eliminated.
b. tax expense shown in the income statement is equal to the deferred taxes shown on the
balance sheet.
c. tax liability shown in the balance sheet is equal to the deferred taxes shown on the previous
year's balance sheet plus the income tax expense shown on the income statement.
d. tax expense shown on the income statement is equal to income taxes payable for the
current year plus or minus the change in the deferred tax asset or liability balances for the
year.
ANS: D

OBJ: LO 1

5. Which of the following temporary differences ordinarily creates a deferred tax asset?
a. Accrued warranty costs
b. Depreciation
c. Installment sales
d. Prepaid insurance
ANS: A

OBJ: LO 1

6. An example of a "deductible temporary difference" occurs when

a. the installment sales method is used for tax purposes, but the accrual method of

recognizing sales revenue is used for financial reporting purposes.

b. accelerated depreciation is used for tax purposes but straight-line depreciation is used for
accounting purposes.
c. warranty expenses are recognized on the accrual basis for financial reporting purposes but
recognized as the warranty conditions are met for tax purposes.
d. the completed-contract method of recognizing construction revenue is used for tax
purposes, but the percentage-of-completion method is used for financial reporting
purposes.
ANS: C

OBJ: LO 1

7. Which of the following situations would require interperiod income tax allocation procedures?
a. A temporary difference exists because the tax basis of capital equipment is less than its
reported amount in the financial statements.
b. Proceeds from an insurance policy on capital equipment lost in a fire exceed the book
value of the equipment.
c. Last period's ending inventory was understated causing both net income and income tax
expense to be understated.
d. Nontaxable interest payments are received on municipal bonds.
ANS: A

OBJ: LO 1

8. An item that would create a permanent difference in pretax financial and taxable incomes would
be
a. using accelerated depreciation for tax purposes and straight-line
depreciation for book purposes.
b. purchasing equipment previously leased with an operating lease in prior years.
c. using the percentage-of-completion method on long-term construction contracts.
d. paying fines for violation of laws.
ANS: D

OBJ: LO 1

9. Which of the following is the most likely item to result in a deferred tax asset?
a. Using accelerated depreciation for tax purposes but straight-line depreciation for
accounting purposes
b. Using the completed-contract method of recognizing construction revenue tax purposes,
but using percentage-of-completion method for financial reporting purposes
c. Prepaid expenses
d. Unearned revenues
ANS: D

OBJ: LO 1

10. Which of the following arguments is supportive of allocation of income taxes?

a. Future predictions of net income are enhanced when income taxes are allocated.
b. Income tax expense computed under interperiod tax allocation is a better predictor of
future cash flows than income taxes actually paid.
c. Income tax is not an expense; it is a sharing of profits with government.
d. Income tax expense based on actual payments is more understandable to users than
allocated income taxes.
ANS: A

OBJ: LO 7

11.
Which of the following temporary differences ordinarily results in a deferred tax
liability?
a. Accrued warranty costs
b. Subscription revenue received in advance
c. Unrealized losses on marketable securities
d. Depreciation
ANS: D

OBJ: LO 2

12. When enacted tax rates change, the asset and liability method of interperiod tax allocation
recognizes the rate change as
a. a cumulative effect adjustment.
b. an adjustment to be netted against the current income tax expense.
c. a separate charge to the current year's net income.
d. a separate charge or benefit to income tax expense.
ANS: D

OBJ: LO 4

13. Recognizing tax benefits in a loss year due to a loss carryforward requires
a. only a footnote disclosure.
b. creating a new carryforward for the next year.
c. creating a deferred tax asset.
d. creating a deferred tax liability.
ANS: C

OBJ: LO 3

14. A company would most likely choose the carryforward option for a net operating loss if the
company expected
a. higher tax rates in the future compared to the past.
b. lower tax rates in the future compared to the past.
c. lower earnings in the future compared to the past.
d. higher earnings in the future compared to the past.
ANS: A

OBJ: LO 3

15. All of the following can result in a temporary difference between pretax financial income and
taxable income except for
a. payment of premiums for life insurance.
b. depreciation expense.
c. contingent liabilities.
d. product warranty costs.
ANS: A

OBJ: LO 1

16. Which of the following items results in a temporary difference deductible amount for a given
year?
a. Premiums on officer's life insurance (company is beneficiary)
b. Premiums on officer's life insurance (officer is beneficiary)
c. Vacation pay accrual
d. Accelerated depreciation for tax purposes; straight-line for financial reporting purposes
ANS: C

OBJ: LO 1

17.
Which of the following items results in a temporary difference taxable amount for a
given year?
a. Premiums on officer's life insurance (company is beneficiary)
b. Premiums on officer's life insurance (officer is beneficiary)
c. Vacation pay accrual
d. Accelerated depreciation for tax purposes; straight-line for financial reporting purposes
ANS: D

OBJ: LO 1

18. Alpha Company reported net incomes in 2004 and 2005 before sustaining a significant operating
loss in 2006. All of the 2006 loss can be carried back against the income of 2004 and 2005 for
purposes of determining the company's 2006 income tax liability. How should the carryback be
presented in the company's 2006 financial statements?
a. As an extraordinary item in the income statement
b. As a revenue from operations in the income statement
c. As the correction of an error in the retained earnings statement
d. As a reduction in the operating loss on the income statement for the year 2006
ANS: D

OBJ: LO 3

19. Which of the following statements is not correct?

a. All current deferred tax liabilities and assets shall be offset and presented as a single
amount on the balance sheet.
b. Deferred tax assets related to carryforwards shall be classified as current or noncurrent on
the balance sheet based on their expected date of reversal.
c. All current and noncurrent deferred tax assets shall be offset and presented as a single
amount on the balance sheet.
d. Deferred tax liabilities and assets shall be classified as current or nocurrent on the balance
sheet based on the classification of the asset or liability giving rise to the deferred tax item.
ANS: C

OBJ: LO 5

20. A deferred tax liability arising from the use of an accelerated method of depreciation for tax
purposes and the straight-line method for financial reporting purposes would be classified on the
balance sheet as
a. a current liability.
b. a noncurrent liability.
c. a current liability for the portion of the temporary difference reversing within a year and a
noncurrent liability for the remainder.
d. an offset to the accumulated depreciation reported on the balance sheet.
ANS: B

OBJ: LO 5

21. International accounting standards currently are moving toward the

a. no-deferral approach.
b. partial recognition approach.
c. comprehensive recognition approach.
d. discounted comprehensive recognition approach.
ANS: C

OBJ: LO 7

22. If all temporary differences entering into the determination of pretax accounting income are
considered in the computation of deferred taxes and income tax
expense, then
a. the no-deferral approach is being applied.

b. the comprehensive recognition approach is being applied.

c. the partial recognition approach is being applied.
d. the net-of-tax method is being applied.
ANS: B

OBJ: LO 7

23. The asset-liability method of interperiod tax allocation currently required by U.S. GAAP is an
example of the
a. discounted comprehensive recognition approach.
b. no-deferral approach.
c. partial recognition approach.
d. comprehensive recognition approach.
ANS: D

OBJ: LO 7

24. Historically, the United Kingdom has recognized only those deferred tax liabilities expected to
"crystallize." The term "crystallize" is most nearly synonymous with the term
a. amortized.
b. realized.
c. recognized.
d. liquidated.
ANS: B

OBJ: LO 7

25. On the statement of cash flows using the indirect method, an increase in the deferred tax liability
would be shown as
a. an addition to net income.
b. a deduction from net income.
c. an increase in investing activities.
d. an increase in financing activities.
ANS: A

OBJ: LO 6

26. In 2005, Eric Corporation reported $90,000 net income before income taxes. The income tax rate
for 2005 was 30 percent. Eric had an unused $60,000 net operating loss carryforward arising in
2004 when the tax rate was 35 percent. The income tax expense Eric would report for 2005
would be
a. $6,000.
b. $9,000.
c. $10,500.
d. $27,000.
ANS: B

OBJ: LO 3

27. The Gayle Corporation reported a $66,000 operating loss in 2005. In the preceding three years,
Gayle reported the following income before taxes and paid the indicated income taxes:
Year
Income
Taxes
Tax Rate
2002
2003
2004

$36,000
24,000
48,000

$10,800
8,400
16,200

30%
35%
35%

The amount of tax benefit to be reported in 2005 arising from the tax carryback provisions of the
current tax code would be
a. $23,100.
b. $22,500.
c. $21,300.
d. $19,200.

ANS: A
OBJ: LO 3
28. The Indy Company had taxable income of $12,000 during 2005. Indy used accelerated
depreciation for tax purposes ($3,400) and straight-line depreciation for accounting purposes
($2,000). Assuming Indy had no other temporary differences, what would the company's pretax
accounting income be for 2005?
a. $1,400
b. $6,600
c. $13,400
d. $17,400
ANS: C

OBJ: LO 2

29. The following information is taken from Blackhawk Corporation's 2005 financial records:
Pretax accounting income .............................
Excess tax depreciation ..............................
Taxable income .......................................

$1,500,000
(45,000)
$1,455,000

Assume the taxable temporary difference was created entirely in 2005 and will reverse in equal
net taxable amounts in each of the next three years. If tax rates are 40 percent in 2005, 35 percent
in 2006, 35 percent in 2007, and 30 percent in 2008, then the total deferred tax liability
Blackhawk should report on its December 31, 2005, balance sheet is
a. $13,500.
b. $15,000.
c. $15,750.
d. $18,000.
ANS: B

OBJ: LO 4

30. The following information was taken from Buccaneer Corporation's 2005 income statement:
Income before income taxes ...............
Income tax expense:
Current ................................
Deferred ...............................
Net income ...............................

$1,500,000
$564,000
36,000

600,000
900,000

Buccaneers' first year of operations was 2005. The company has a 30 percent tax rate.
Management decided to use accelerated depreciation for tax purpose and the straight-line method
of depreciation for financial reporting purposes. The amount charged to depreciation expense in
2005 was $600,000. Assuming no other differences existed between book income and taxable
income, what amount did Buccaneer deduct for depreciation on its tax return for 2005?
a. $480,000
b. $570,000
c. $600,000
d. $720,000
ANS: D

OBJ: LO 2

31. Warren Corporation began operations in 2002 and had operating losses of $400,000 in 2003 and
$300,000 in 2004. For the year ended December 31, 2005, Warren had a pretax financial income
of $600,000. For 2003 and 2004, assume an enacted tax rate of 30 percent, and for 2005 a 35
percent tax rate. There were no temporary differences in any of the years. In Warren's 2005
income statement, how much should be reported as income tax expense?
a. $0

b. $30,000
c. $180,000
d. $210,000
ANS: A

OBJ: LO 3

32. On December 31, 2004, Alton, Inc., reported a current deferred tax liability of $140,000 and a
noncurrent deferred tax asset of $40,000. At the end of 2005, Alton reported a current deferred
tax liability of $100,000, and a noncurrent deferred tax liability of $44,000. The deferred tax
expense for 2005 is
a. $144,000.
b. $44,000.
c. $36,000.
d. $4,000.
ANS: B

OBJ: LO 2

33. Eden Company had pretax accounting income of $24,000 during 2005. Eden's only temporary
difference for 2005 relates to a sale made in 2003 and recognized for accounting purposes at that
time. However, Eden uses the installment sales method of revenue recognition for tax purposes.
During 2005 Eden collected a receivable from the 2003 sale which resulted in $6,000 of income
under the installment sales method. Eden's taxable income for 2005 would be
a. $6,000.
b. $18,000.
c. $24,000.
d. $30,000.
ANS: D

OBJ: LO 2

34. Begal Corporation paid $20,000 in January of 2005 for premiums on a two- year life insurance
policy which names the company as the beneficiary. Additionally, Begal Corporation's financial
statements for the year ended December 31, 2005 revealed the company paid $105,000 in taxes
during the year and also accrued estimated litigation losses of $200,000. Assuming the lawsuit
was resolved in February of 2006 (at which time a $200,000 loss was recognized for tax
purposes) and that Begal's tax rate is 30 percent for both 2005 and 2006, what amount should
Begal report as asset for net deferred income taxes on its 2005 balance sheet?
a. $54,000
b. $57,000
c. $60,000
d. $66,000
ANS: C

OBJ: LO 2

35. Dodger Corporation reported a loss for both financial reporting purposes and tax reporting
purposes of $231,000 in 2005. For financial reporting purposes, Dodger reported income before
taxes for years 2002-2004 as listed below:
2002 ............................
2003 ............................
2004 ............................

$ 66,000
99,000
132,000

Assuming Dodger's tax rate is 30 percent in all periods, and that the company uses the carryback
provisions, what amount should appear in Dodger's statements for financial reporting purposes as
a net loss in 2005?
a. $0

b. $69,300
c. $161,700
d. $234,300
ANS: C

OBJ: LO 3

36. Analysis of the assets and liabilities of Marie Corp. on December 31, 2005, disclosed assets with
a tax basis of $1,000,000 and a book basis of $1,300,000. There was no difference in the liability
basis. The difference in asset basis arose from temporary differences that would reverse in the
following years:
2006
2007
2008
2009
2010

............................
............................
............................
............................
............................

$80,000
70,000
72,000
40,000
38,000

The enacted tax rates are 30 percent for the years 2005-2008 and 35 percent for 2009-2012 The
total deferred tax liability on December 31, 2005, should be
a. $105,000.
b. $93,900.
c. $90,000.
d. $69,000.
ANS: B

OBJ: LO 4

37. Schaeffer Products, Inc., reported an excess of warranty expense over warranty deductions of
$72,000 for the year ended December 31, 2005. This temporary difference will reverse in equal
amounts over the years 2006 to 2008. The enacted tax rates are as follows:
2005
2006
2007
2008

............................
............................
............................
............................

40%
35%
30%
25%

The reporting for this temporary difference at December 31, 2005, would be
a. a deferred tax liability of $28,800.
b. a deferred tax asset of $28,800.
c. a current deferred tax liability of $8,400 and a noncurrent deferred tax liability of $13,200.
d. a current deferred tax asset of $8,400 and a noncurrent deferred tax asset of $13,200.
ANS: D

OBJ: LO 4

38. In 2006, The Worf Company, reported pretax financial income of $500,000. Included in that
pretax financial income was $90,000 of nontaxable life insurance proceeds received as a result of
the death of an officer; $120,000 of warranty expenses accrued but unpaid as of December 31,
2006; and $20,000 of life insurance premiums for a policy for an officer. Assuming that no
income taxes were previously paid during the year and assuming an income tax rate of 40
percent, the amount of income taxes payable on December 31, 2006, would be
a. $180,000.
b. $200,000.
c. $212,000.
d. $220,000.
ANS: D

OBJ: LO 2

39. Fieldcrest Company, newly formed on January 1, 2005, prepared a temporary difference reversal
schedule at the end of 2006 that disclosed the following taxable income (loss) amounts before
application of the carryback/carryforward rules:
2005
2006
2007
2008
2009

............................
............................
............................
............................
............................

$ 64,000
(128,000)
(12,000)
80,000
20,000

The enacted tax rate for all years was 30 percent. Using the provisions of FASB Statement No.
109, the total noncurrent deferred tax liability on December 31, 2006, was
a. $0.
b. $7,200.
c. $10,800.
d. $30,000.
ANS: B

OBJ: LO 2

40. For three consecutive years, 2003-2005, Twins Corporation has reported income before taxes of
$100,000 for both financial reporting purposes and tax reporting purposes. During this time,
Twins income tax rates were as follows:
2003 ............................
2004 ............................
2005 ............................

20%
25%
30%

In 2006, Twins' tax rate changed to 35 percent. Also in 2006, the company reported a loss for
both financial reporting and tax reporting purposes of $100,000. Assuming the company uses the
carryback provisions, the amount Twins' should report as an income tax refund receivable in 2006
is
a. $20,000.
b. $25,000.
c. $30,000.
d. $35,000.
ANS: B

OBJ: LO 3

41. Viking Corporation reported depreciation of $250,000 on its 2005 tax return. However, in its
2005 income statement, Viking reported depreciation of $100,000. The difference in depreciation
is a temporary difference that will reverse over time. Assuming Viking's tax rate is constant at 30
percent, what amount should be added to the deferred income tax liability in Viking's December
31, 2005, balance sheet?
a. $30,000
b. $37,500
c. $45,000
d. $75,000
ANS: C

OBJ: LO 2

42. Cowboy Corporation reported depreciation of $450,000 on its 2005 tax return. However, in its
2005 income statement, Cowboy reported depreciation of $300,000--as well as $30,000 interest
revenue on tax-free bonds. The difference in depreciation is only a temporary difference, and it
will reverse equally over the next three years. Cowboy's enacted income tax rates are as follows:

2005
2006
2007
2008

............................
............................
............................
............................

35%
30%
25%
20%

What amount should be included in the deferred income tax liability in Cowboy's December 31,
2005, balance sheet?
a. $30,000
b. $37,500
c. $45,000
d. $52,500
ANS: B

OBJ: LO 2

43. The books of the Tracker Company for the year ended December 31, 2005, showed pretax
income of $360,000. In computing the taxable income for federal income tax purposes, the
following timing differences were taken into account:
Depreciation deducted for tax purposes in excess of
depreciation recorded on the books .....................
Income from installment sale reportable for tax purposes
in excess of income recognized on the books ............

$16,000
12,000

What should Tracker record as its current federal income tax liability at December 31, 2005,
assuming a corporate income tax rate of 30 percent?
a. $99,600
b. $103,200
c. $106,800
d. $108,000
ANS: C

OBJ: LO 2

44. Frey Corporation's income statement for the year ended December 31, 2005, shows pretax
income of $1,000,000. The following items are treated differently on the tax return and in the
accounting records:

Rent income ...........................

Depreciation expense ..................
Premiums on officers' life insurance ..

Tax
Return

Accounting
Records

$ 70,000
280,000
--

$120,000
220,000
90,000

Assume that Frey's tax rate for 2005 is 30 percent. What is the amount of income tax payable for
2005?
a. $360,000
b. $320,000
c. $294,000
d. $267,000
ANS: C

OBJ: LO 2

45. Inventive Corporation's income statement for the year ended December 31, 2005, shows pretax
income of $300,000. The following items are treated differently on the tax return and in the
accounting records:

10

Warranty expense ......................

Depreciation expense ..................
Premiums on officers' life insurance ..

Tax
Return

Accounting
Records

$170,000
150,000
--

$185,500
100,000
60,000

Assume that Inventive's tax rate for 2005 is 40 percent. What is the current portion of Inventive's
total income tax expense for 2005?
a. $106,200
b. $120,200
c. $130,200
d. $144,200
ANS: C

OBJ: LO 2

46. During a year, Great Northern Company reported income tax expense of $200,000. The amount
of taxes currently payable remained unchanged from the beginning to the end of the year. The
deferred tax liability classified as noncurrent that resulted from the use of MACRS for tax
purposes and straight-line depreciation for financial reporting purposes, increased from $40,000
at the beginning of the year to $44,000 at the end of the year. How much cash was paid for
income taxes during for the year?
a. $156,000
b. $160,000
c. $196,000
d. $206,000
ANS: C

OBJ: LO 6

47. For the current year, Northern Pacific Company reported income tax expense of $45,000. Income
taxes payable at the end of the prior year were $20,000 and at the end of the current year were
$27,000. The deferred tax liability classified as noncurrent that resulted from the use of MACRS
for tax purposes and straight-line depreciation for financial reporting purposes increased from
$18,000 at the beginning of the current year to $23,000 at the end of the current year. How much
cash was paid for income taxes during the year?
a. $33,000
b. $45,000
c. $38,000
d. $47,000
ANS: A

OBJ: LO 6

48. For the current year, Santa Fe Company reported income tax expense of $195,000. Income taxes
payable at the end of the prior year were $125,000 and at the end of the current year were
$130,000. The deferred tax liability classified as noncurrent that resulted from the use of MACRS
for tax purposes and straight-line depreciation for financial reporting purposes increased from
$120,000 at the beginning of the current year to $123,000 at the end of the current year. How
much cash was paid for income taxes during the year?
a. $187,000
b. $197,000
c. $195,000
d. $190,000
ANS: A

OBJ: LO 6

11

49. For the current year, Northern Pacific Company reported income tax expense of $11,000. Income
taxes payable at the end of the prior year were $9,000 and at the end of the current year were
$10,000. The deferred tax liability classified as noncurrent that resulted from the use of MACRS
for tax purposes and straight-line depreciation for financial reporting purposes increased from
$11,000 at the beginning of the current year to $13,000 at the end of the current year. How much
cash was paid for income taxes during the year?
a. $8,000
b. $10,000
c. $11,000
d. $9,000
ANS: A

OBJ: LO 6

PROBLEMS
1. Garrison Designs, Inc., a corporation organized on January 1, 1996, reported the following
incomes (losses) for the ten-year period, 1996-2005:
Year

Income (Loss)

1996
1997
1998
1999
2000
2001
2002
2003
2004
2005

$ 16,000
(40,000)
16,000
24,000
(32,000)
16,000
32,000
64,000
80,000
(16,000)

Income Tax Rate

50%
50
48
48
45
42
42
34
34
30

Income Tax Paid

$ 8,000
0
7,680
11,520
0
6,720
13,440
21,760
27,200
0

Applying the carryback provisions in the tax law, compute the net amount of taxes paid (amounts
paid less refunds) for the ten-year period ending December 31, 2005.
ANS:
Income taxes paid through December 31, 2001, net to zero because the $40,000 net operating loss
in 1994 and the $32,000 net operating loss in 2000 are applied against the entire income earned
for the years 1996, 1998, 1999, and 2001.
Net taxes paid between January 1, 2002, and December 31, 2005, were:
Year
2002
2003 (after applying 2005 loss)
2004
2005

Net Taxes Paid

$13,440
16,320
27,200
-$56,960

Total income taxes actually paid (1996 2005)

OBJ:

LO 3

12

2.
The following differences between financial and taxable income were reported
by Dider Corporation for the current year:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)

Excess of tax depreciation over book depreciation ....

Interest revenue on municipal bonds ..................
Excess of estimated warranty expense over actual
expenditures .........................................
Unearned rent received ...............................
Fines paid ...........................................
Excess of income reported under percentage-ofcompletion accounting for financial reporting over
completed-contract accounting used for tax reporting .
Interest on indebtedness incurred to purchase taxexempt securities ....................................
Unrealized losses on marketable securities recognized
for financial reporting ..............................

$60,000
9,000
54,000
12,000
30,000
45,000
3,000
18,000

Assume that Dider Corporation had pretax accounting income [before considering items (a)
through (h)] of $900,000 for the current year. Compute the taxable income for the current year.
ANS:
Pretax financial income ..................................
Add (deduct) permanent differences:
(b) Tax-exempt interest .............................
(e) Fines paid ......................................
(g) Interest expense on funds used to purchase taxexempt securities ...............................
Subtotal .....................................
Add (deduct) timing differences:
(a) Excess of tax over book depreciation ............
(c) Excess of warranty expense over actual expenditures
....................................
(d) Unearned rent received ..........................
(f) Excess of percentage-of-completion income over
completed contract income .......................
(h) Unrealized loss on marketable securities ........
Taxable income ...............................

OBJ:

$900,000
(9,000)
30,000
3,000
$924,000
(60,000)
54,000
12,000
(45,000)
18,000
$903,000

LO 2

3. Walsh Services computed pretax financial income of $220,000 for its first year of operations
ended December 31, 2005. In preparing the income tax return for the year, the tax accountant
determined the following differences between 2005 financial income and taxable income:
(1)
(2)
(3)

Nondeductible expenses ..............................

Nontaxable revenues .................................
Temporary difference--Installment sales reported in
financial income but not in taxable income ..........

$40,000
14,000
70,000

The temporary difference is expected to reverse in the following pattern:

2006 .....................................................
2007 .....................................................
2008 .....................................................

13

$14,000
32,000
24,000
$70,000

The enacted tax rates for this year and the next three years are as follows:
2005
2006
2007
2008

.....................................................
.....................................................
.....................................................
.....................................................

40%
35%
32%
30%

Use the provisions of FASB Statement No. 109.

(1) Prepare a schedule showing the reversal of the temporary differences and the
computation of income taxes payable and deferred tax assets or liabilities as of
December 31, 2005.
(2) Prepare journal entries to record income taxes payable and deferred income taxes.
(3) Prepare the income statement for Walsh Services beginning with "Income from
continuing operations before income taxes" for the year ended December 31, 2005.
ANS:
(1)
Reversal Years
2005
Pretax financial income
Nondeductible expense
Nontaxable revenue
Taxable financial
income
Temporary difference:
Gross profit on
installment sales
Taxable income
Enacted tax rate
Income taxes payable
Deferred tax liability:
Current
Noncurrent

2006

2007

2008

(70,000)

$14,000

$32,000

$24,000

$176,000
40%
$ 70,400

$14,000
35%

$32,000
32%

$24,000
30%

$10,240

$ 7,200

$220,000
40,000
(14,000)
$246,000

$ 4,900

(2)
2005 Journal Entries:
Income Tax Expense--Current ...............
Income Taxes Payable ....................
Income Tax Expense--Deferred ..............
Deferred Tax Liability--Current .........
Deferred Tax Liability--Noncurrent ......

70,400
70,400
22,340

4,900
17,440

(3)
2005 Income Statement Presentation:
Income from continuing operations before
income taxes ..............................
Less income taxes:
Current provision .......................
Deferred provision ......................
Income from continuing operations .........

OBJ:

LO 4

14

$220,000
$ 70,400
22,340

92,740
$127,260

4. Millcroft Inc. computed a pretax financial income of $40,000 for the first year of its operations
ended December 31, 2005. Analysis of the tax and book basis of its liabilities disclosed $360,000
in unearned rent revenue on the books that had been recognized as taxable income in 2005 when
the cash was received.
The unearned rent is expected to be recognized on the books in the following pattern:
2006
2007
2008
2009

....................................................
....................................................
....................................................
....................................................

$ 90,000
160,000
70,000
40,000
$360,000

The enacted tax rates for this year and the next four years are as follows:
2005
2006
2007
2008
2009

....................................................
....................................................
....................................................
....................................................
....................................................

40%
36%
33%
30%
32%

Use the provisions of FASB Statement No. 109.

(1)
(2)
(3)

Prepare a schedule showing the reversal of the temporary difference and the
computation of income taxes payable and deferred tax assets or liabilities as of
December 31, 2005.
Prepare journal entries to record income taxes payable and deferred income taxes.
Prepare the income statement for Millcroft beginning with "Income from
continuing operations before income taxes" for the year ended December 31, 2005.

ANS:
(1)
2005
Taxable financial
income
Temporary difference:
Unearned rent revenue
Rent revenue earned
Taxable income (loss)
Enacted tax rate
Income taxes payable
Reversal of dta

$40,000
360,000
0
$400,000

Reversal Years
2007

2006
$

2008
$

2009
0

(90,000)
$(90,000)

(160,000)
$(160,000)

(70,000)
$(70,000)

(40,000)
$(40,000)

0.36

0.33

0.30

0.32

0.4
160,000

(32,400)
(52,800)
(21,000)
(12,800)
current dta noncurrent noncurr.
noncurent
dta
dta
dta

(2)
Income Tax Expense..........................
Deferred Tax Asset--Current ................
Deferred Tax Asset--Noncurrent .............
IncomeTaxPayable..................

(3)
2005 Income Statement Presentation:
Income from continuing operations before

15

41,000
32,400
86,600
160,000

income taxes ................................

Less income taxes:
Current provision ............................
Deferred benefit .............................
Income from continuing operations ............

OBJ:

$40,000
160,000
119,000

41,000
$(1,000)

LO 4

5. Radford Appliances computed a pretax financial loss of $60,000 for the first year of its operations
ended December 31, 2005. Analysis of the tax and book basis of its liabilities disclosed $80,000
in accrued warranty expenses on the books that had not been deductible from taxable income in
2005, but would be deductible in future years when the warranty expenses were paid.
The future warranty payments are expected to occur in the following pattern:
2006
2007
2008
2009

....................................................
....................................................
....................................................
....................................................

$14,000
36,000
18,000
12,000
$80,000

The enacted tax rates for this year and the next four years are as follows:
2005
2006
2007
2008
2009

....................................................
....................................................
....................................................
....................................................
....................................................

40%
35%
32%
30%
30%

Use the provisions of FASB Statement No. 109.

(1)
(2)
(3)

Prepare a schedule showing the reversal of the temporary difference and the
computation of income taxes payable and deferred tax assets or liabilities as of
December 31, 2005.
Prepare journal entries to record income taxes payable and deferred income taxes.
Prepare the income statement for Radford beginning with "Income from continuing
operations before income taxes" for the year ended December 31, 2005.

ANS:
(1)
2005
Taxable financial
income (loss)
Temporary
differences:
Estimated warranty
payment in future
years
Deductible amountwarranty payments
Taxable income
(loss)
Enacted tax rate
Income taxes payable

2006

$(60,000)

Reversal Years
2007

2008
0

2009
0

80,000

$ 20,000
0.4

(14,000)

(36,000)

(18,000)

(12,000)

$(14,000)

$(36,000)

$(18,000)

$(12,000)

0.35

0.32

0.30

0.30

$8,000
Reversal of deferred

16

tax asset

($4,900)
current dta

($11,520)
noncurrent
dta

($5,400)
noncurrent
dta

($3,600)

noncurrent
dta

(2)
2005 Journal Entries
Deferred Tax Asset--Current ..................
Deferred Tax Asset--Noncurrent................
Income Tax Benefit--Deferred.....
Income Tax Payable ..............

4,900
20,520
17,420
8,000

(3)
2005 Income Statement Presentation:
Loss from continuing operations before income
taxes ........................................
Less income taxes:
Current provision ..........................
Deferred benefit ...........................
Loss from continuing operations ..............

OBJ:

($60,000)
$ 8,000
($25,420)

17,420
$(42,580)

LO 4

6. Seta Associates computed a pretax financial income of $280,000 for the first year of its
operations ended December 31, 2005. Included in financial income was $20,000 of nondeductible
expense and $70,000 gross profit on installment sales that was deferred for tax purposes until the
installments were collected.
The temporary differences are expected to reverse in the following pattern.
Gross Profit on Collections
2006 ...................................................
2007 ...................................................
2008 ...................................................

$20,000
30,000
20,000
$70,000

The enacted tax rates for this year and the next three years are as follows:
2005
2006
2007
2008

...................................................
...................................................
...................................................
...................................................

(1)

Prepare a schedule showing the reversal of the temporary differences and the
computation of income taxes payable and deferred tax assets or liabilities as of
December 31, 2005.

(2)

Prepare journal entries to record income taxes payable and deferred income taxes.

(3)

Prepare the income statement for Seta beginning with "Income from continuing
operations before income taxes" for the year ended December 31, 2005.

ANS:
(1)
Reversal Years

17

40%
35%
32%
30%

2005
Pretax
financial
income (loss)
Nondeductible
expense
Taxable
financial
income (loss)
Temporary
difference:
Gross profit
on installment
sales
Taxable
amount-collections
Taxable income
(loss)
Enacted tax
rate
Income taxes
payable
(40% x
$230,000)
Deferred tax
liability:
Current (35%
$20,000)
Noncurrent
(32%
$30,000) +
(30% 20,000)

2006

2007

2008

$20,000

$30,000

$20,000

$20,000

$30,000

$20,000

$280,000
20,000
$300,000

(70,000)

$230,000
40%

35%

32%

30%

$92,000

7,000
15,600

Under the provisions of the proposed modification to FASB Statement No. 109, the classification
of the deferred tax liability into current and noncurrent portions follows the classification of the
underlying installment receivable.
(2)
2005 Journal Entries
Income Tax Expense--Current .................
Income Taxes Payable ......................
Income Tax Expense--Deferred ................
Deferred Tax Liability--Current ...........
Deferred Tax Liability--Noncurrent ........

92,000

92,000

22,600
7,000
15,600

(3)
2005 Income Statement Presentation:
Income from continuing operations before income
taxes ................................
Less income taxes:
Current provision .........................
Deferred provision ........................
Income from continuing operations ...........

18

$280,000
$92,000
22,600

114,600
$165,400

OBJ:

LO 4

7. Cardinal Industries computed a pretax financial income of $118,500 for the first year of its
operations ended December 31, 2005. Cardinal uses an accelerated cost recovery method on its
tax return, and straight-line depreciation on its books.
The difference between the tax and book deduction for depreciation over the five-year life of the
assets acquired in 2005 are as follows:
2005
2006
2007
2008
2009

..................................................
..................................................
..................................................
..................................................
..................................................

$(24,000)
(39,000)
(9,000)
30,000
42,000
$
0

The enacted tax rates for this year and the next four years are as follows:
2005
2006
2007
2008
2009

..................................................
..................................................
..................................................
..................................................
..................................................

40%
38%
36%
35%
32%

Use the provisions of FASB Statement No. 109 and assume that it is more likely than not that
income will be sufficient in all future years to realize any deductible amounts.
(1)
(2)
(3)

Prepare a schedule showing the pattern of depreciation differences, the computation

of income taxes payable, and deferred tax assets or liabilities as of December 31,
2005.
Prepare journal entries to record income taxes payable and deferred income taxes.
Prepare the income statement for Cardinal Industries beginning with "Income from
continuing operations before income taxes" for the year ended December 31, 2005.

ANS:
(1)
2005
Taxable financial income
Temporary difference
between tax and book
depreciation
Taxable income (loss)
Enacted tax rate
Income taxes payable
(Increase)/decrease in DTL
Reversal rate (2008) for first reversal
DTL to record in 2005

2006

Reversal Years
2007

2008

2009

$118,500
(24,000)
$ 94,500
40%
$37,800

$(39,000)
$(39,000)
38%

$(9,000)
$(9,000)
36%

$30,000
$30,000
35%

$42,000
$42,000
32%

($24,000)

($39,000)

($9,000)

$30,000

$42,000

0.35
($8,400)

Under the provisions of FASB Statement No. 109, the classification of the deferred tax asset and
liability as noncurrent follows the classification of the underlying depreciable asset.
(2)

19

2005 Journal Entries

Income Tax Expense--Current .................
Income Taxes Payable ......................
Deferred Tax Liability ....................

46,200
37,800
8,400

(3)
2005 Income Statement Presentation:
Income from continuing operations before income
taxes ................................
Less income taxes:
Current provision .........................
Deferred provision ........................
Income from continuing operations ...........

OBJ:

$118,500
$ 37,800
8,400

46,200
$72,300

LO 4

8. Halverson Company reported taxable income of $60,000 for 2005, its first year of operations.
This amount reflects temporary differences between financial and taxable income that are
scheduled to reverse in subsequent years as shown below. As of December 31, 2005, the enacted
tax rate for 2005 and future years was 40 percent.
Temporary Difference Reversals
Taxable (Deductible)
Year
Amounts
2006
2007
2008
2009
2010

$(24,000)
27,000
(36,000)
(18,000)
101,000

Use the provisions of FASB Statement No. 109 and assume that it is more likely than not that
income will be sufficient in all future years to realize any deductible amounts. Also assume that
all the temporary differences relate to noncurrent items.
Compute the amount of the deferred tax assets and/or liabilities that would be reported on
Halverson's balance sheet as of December 31, 2005.
ANS:
Since future tax rates are unchanging and since FASB Statement No. 109 classifies deferred tax
assets and liabilities according to the classification of the underlying items and not the expected
time of reversal, no scheduling is necessary in this case.
Noncurrent deferred tax liability: ($50,000 0.40) = $20,000
OBJ:

LO 2

9. A major conceptual issue associated with interperiod tax allocation is the issue of discounting the
deferred tax amount on the balance sheet to reflect its present value. Current generally accepted
accounting principles do not allow the discounting of deferred taxes. Some in the profession have
suggested, however, that the FASB should reconsider its position on discounting in light of the
Board's current project on present value-based measurements in accounting.
Provide arguments for and against the discounting of deferred income taxes.

20

ANS:
Proponents of discounting argue that without discounting the deferred tax asset or liability, the
financial statements fail to indicate the appropriate benefit of the deferral of taxes or the burden
of prepayment of taxes. Dollars related to short-term deferrals appear to have the same value on
the financial statements as dollars related to longer term deferrals. This inconsistency impairs the
comparability of the financial statements. Discounting would result in temporary differences that
do not reverse until many years in the future being reflected at the present value of the expected
future cash flows. The proponents argue that the discounting of deferred taxes is consistent with
currently generally accepted accounting principles for long-term notes receivable and payable,
pensions, and leases.
Opponents of discounting argue that discounting results in a mismatching of the full tax effects of
taxable transactions with the transactions themselves. The basic transaction that results in taxes
occurs in one period, and the related tax effects are recorded in subsequent periods through the
recording of interest on the deferred tax balance. Discounting also tends to conceal the
consequences of transactions because they are hidden in the subsequent interest expense.
Opponents further argue that deferred taxes are an interest free loan from the government thus
eliminating the need for discounting.
OBJ:

LO 5

10. A major conceptual issue regarding the accounting for income taxes is the recognition of income
taxes as expenses. Some would argue that income taxes are not directly related to revenues or
revenue-seeking functions and should not be considered as expenses. Some view income taxes as
a distribution of income similar to dividends. This view would hold that income taxes, like
dividends, are paid only if income is earned. Wages and supplies, on the other hand, are paid for
whether the entity earns a profit or incurs a loss.
Identify arguments that can be made for recognizing income tax as an expense on the income
statement.
ANS:
Perhaps the strongest argument for recognizing income taxes as an expense rather than as a
distribution is the fact that the government, like employees or suppliers, renders a service to the
entity. The federal government does not provide services to an entity in direct proportion to the
amount of tax levied, but it does provide services. Payment of corporate income tax allows an
entity to conduct its business under favorable circumstances such as law, order, and the general
organization of the economy. The federal government contributes to the orderly functioning of
society that allows an enterprise to function and even prosper.
OBJ:

LO 5

21