Chapter 15
Chapter 17 - FASB ASC Topic 740: Income Taxes Chapter 17FASB ASC
Topic 740: Income Taxes
SOLUTIONS MANUAL Discussion Questions 1. (LO 1) Identify some of
the reasons why accounting for income taxes is complex.
U.S. tax laws are complex and ambiguous. A company often
prepares its financial statements (Form 10-K) six months or more in
advance of when the company files its corresponding income tax
returns. The rules that apply to accounting for income taxes are
not found exclusively in ASC 740 (for example, stock options and
business combinations).
2. (LO 1) True or False: ASC 740 applies to all taxes paid by a
corporation. Explain.
False. ASC 740 only applies to income taxes paid by a
corporation.
3. (LO 1) True or False: ASC 740 is the sole source for the
rules that apply to accounting for income taxes. Explain.
False. With the Accounting Standards Codification, the rules
that apply to accounting for income taxes are found primarily in
ASC 740. The codification includes rules previously found in
pronouncements from the Emerging Issues Task Force, opinions from
the former Accounting Principles Board, and pronouncements from the
Securities and Exchange Commission. ASC 740 does not include the
income tax accounting rules that apply to accounting for stock
compensation or business combinations. These rules are found in ASC
718-740 and ASC 805-740.
4. (LO 1) How does the fact that most corporations file their
financial statements several months before they file their income
tax returns complicate the income tax provision process?
When a corporation files its financial statements in advance of
its federal income tax return, management must use judgment to
estimate the actual tax liability that will result when the tax
return is filed. When the tax return is filed, the corporation must
adjust its balance sheet to reflect the actual taxes payable and
make any other adjustments to reflect the companys true current and
deferred tax liabilities. This adjustment often is referred to as a
return-to-provision adjustment or a true-up.
5. (LO 1) What distinguishes an income tax from other taxes?
The FASB defines an income tax as a tax based on income. This
definition excludes property taxes, excise taxes, sales taxes, and
value-added taxes, which are assessed based on sales or value. A
company reports non-income taxes as expenses in the computation of
net income before taxes.
6. (LO 1) Briefly describe the six step process by which a
company computes its income tax provision.
The steps to compute a companys federal income tax provision
proceed as follows:1. Adjust pre-tax net income for all permanent
differences2. Identify all temporary differences and tax
carryforward amounts3. Calculate the current income tax expense or
benefit (refund)4. Determine the ending balances in the balance
sheet deferred tax asset and liability accounts5. Evaluate the need
for a valuation allowance for gross deferred tax assets6. Calculate
the deferred income tax expense or benefit
7. (LO 2) What are the two components of a companys income tax
provision? What does each component represent about a companys
income tax provision?
A company computes its current income tax expense or benefit and
its deferred income tax expense or benefit. The current income tax
expense or benefit represents the income taxes payable or
refundable in the current year. The deferred income tax expense or
benefit represents the amount necessary to adjust the balance sheet
liability or receivable for future income taxes payable or
refundable that result from current and prior year
transactions.
8. (LO 2) True or False: All differences between book and
taxable income, both permanent and temporary, affect a companys
effective tax rate. Explain.
False. Permanent differences affect a companys effective tax
rate. Temporary differences affect a companys effective tax rate
only when the company adjusts its balance sheet deferred income tax
asset or liability to reflect changes in the enacted tax rate or
for changes in valuation allowances related to deferred tax assets
(that is, for prior period adjustments).
9. (LO 2) When does a temporary difference resulting from an
expense (deduction) create a taxable temporary difference? A
deductible temporary difference?
An expense results in a taxable temporary difference when the
tax deduction precedes the book deduction, creating a future
(deferred) tax liability in the period in which the book expense is
recorded. An example is accelerated depreciation elected for tax
purposes and straight line elected for book purposes. An expense
results in a deductible temporary difference when the book
deduction precedes the tax deduction, creating a future (deferred)
tax asset in the period in which the tax expense is deducted. An
example is using the accrual method to record bad debts for book
purposes and the charge-off method for tax purposes.
10. (LO 2) When does a temporary difference resulting from
income create a taxable temporary difference? A deductible
temporary difference?
Income results in a taxable temporary difference when the income
is reported on the financial statement prior to being reported on
the tax return, creating a future (deferred) tax liability in the
period in which the income is reported on the tax return. An
example is use of the installment method for tax purposes and full
reporting of the income for book purposes. Income results in a
deductible temporary difference when the income is reported on the
tax return prior to being reported on the financial statement,
creating a future (deferred) tax asset in the period in which the
book income is reported. An example is reporting a prepayment of
income on the tax return in the year received and reporting the
income for book purposes in the year the income is earned.
11. (LO 2) Briefly describe what is meant by the asset and
liability or balance sheet approach taken by ASC 740 with respect
to computing a corporations deferred tax provision.
Under ASC 740, a companys primary objective is to report its
deferred tax assets and liabilities on the balance sheet at the
amounts the company expects to recover or pay using the enacted tax
rate for the period in which the recovery or payment will take
place. The amount necessary to adjust the beginning balance in the
deferred tax accounts to the ending balance becomes the deferred
income tax expense or benefit recorded as part of the income
statement income tax provision.
12. (LO 2) Why are cumulatively favorable temporary differences
referred to as taxable temporary differences?
Initially favorable temporary differences are those differences
that cause the current years taxable income to be less than the
corresponding net (book) income. As a result, the current year tax
liability will be less than the provision that relates to net
income. When the difference reverses in a future year, taxable
income will exceed net income, and the current year tax liability
will exceed the provision that relates to net income. A company
records this future tax liability (deferred tax liability) in the
year in which the favorable temporary difference arises and
decreases (draws down) the tax liability when the temporary
difference reverses in a future period.
13. (LO 2) Why are cumulatively unfavorable temporary
differences referred to as deductible temporary differences?
Initially unfavorable temporary differences are those
differences that cause the current years taxable income to be
greater than the corresponding net (book) income. As a result, the
current year tax liability will be greater than the provision that
relates to net income. When the difference reverses in a future
year, taxable income will be less than net income, and the current
year tax liability will be less than the provision that relates to
net income. A company records this future tax benefit (deferred tax
asset) in the year in which the unfavorable temporary difference
arises and decreases (draws down) the tax asset when the temporary
difference reverses in a future period.
14. ([LO 2) In addition to the current year tax return taxes
payable or refundable, what other transactions can affect a
companys current income tax provision?
The current year income taxes payable or refundable also can be
affected by 1) tax refunds or additional tax deficiencies from
prior year tax returns that result from an IRS audit; 2) prior year
income tax refunds from current year carrybacks; 3) the portion of
tax benefits from the exercise of nonqualified stock options that
were not previously recorded as temporary differences under ASC 718
or APB 25; or 4) increases in the unrecognized tax benefit (income
taxes payable) under ASC 740.
15. (LO 2, 4) What is an unrecognized tax benefit and how does
it affect a companys current income tax expense?
An unrecognized tax benefit is the amount of income taxes a
company expects to pay as the result of future income tax return
audits by tax authorities. Thought of another way, it is the amount
of income tax benefits the company will have to return in the
future as a result of income tax return audits by tax authorities.
Those taxes a company expects to pay within the next 12 months are
classified as current taxes payable on the balance sheet. Additions
to the unrecognized tax benefit are treated as part of the current
income tax expense even if the corporation expects to resolve the
uncertain tax position beyond the next 12 months.
16. (LO 2) True or False: When Congress changes the corporate
tax rates, only the current year book-tax temporary differences are
measured using the new rates. Explain.
False. When Congress changes the enacted corporate tax rates, a
company must adjust its total deferred tax asset and deferred tax
liability accounts on its balance sheet to reflect the income tax
benefit or expense that will result under the new rate in the
future. The adjustment to the deferred tax accounts will be
recorded as an increase or decrease to the deferred tax expense or
benefit and will appear in the reconciliation of the companys
effective tax rate as a prior period adjustment.
17. (LO 2) True or False: All temporary differences have a
financial accounting basis. Explain.
False. Not all temporary differences have a financial accounting
basis. Net operating loss and net capital loss carryovers create
deferred tax assets but do not have a financial accounting basis.
Organizational expenditures also do not have an accounting basis on
the balance sheet but result in a deferred tax asset if capitalized
for tax purposes.
18. (LO 3) What is the purpose behind a valuation allowance as
it applies to deferred tax assets?
A valuation allowance operates as a contra account to the
deferred tax assets on the balance sheet. If a company determines
that it is more likely than not (a likelihood greater than 50%)
that some portion or all of the deferred tax assets will not be
realized in a future period (that is, reduce future taxable income
or future tax liability), the company must offset the deferred tax
assets with a valuation allowance to reflect the amount it does not
expect to realize in the future.
19. (LO 3) What is the difference between recognition and
realization as it applies to the recording of a deferred tax asset
on a balance sheet?
Recognition relates to whether it is probable the company has
the right to a future tax benefit, in which case the company can
record the deferred tax asset on the balance sheet. Realization
relates to whether it is more likely than not the company expects
to have sufficient taxable income or tax liability in the future to
absorb the future tax deductions or credits when they are reported
on the tax return or before they expire.
20. (LO 3) Briefly describe the four sources of taxable income a
company evaluates in determining if a valuation allowance is
necessary.
The four sources of taxable income that are considered in the
valuation allowance process are as follows:1. Future reversals of
existing favorable (taxable) temporary differences;2. Taxable
income in prior carryback year(s);3. Expected future taxable income
exclusive of reversing temporary differences and carryforwards;
and4. Taxable income that will result from prudent tax planning
strategies.
21. (LO 3) Which of the four sources of taxable income are
considered objective and which are considered subjective? Which of
these sources generally receives the most weight in analyzing
whether a valuation allowance is necessary?
The objective sources are future reversals of existing favorable
(taxable) temporary differences and taxable income in prior
carryback years. The subjective sources are expected future taxable
income exclusive of reversing taxable temporary differences and
carryforwards and taxable income that will result from tax planning
strategies. Objective sources of taxable income generally receive
more weight when analyzing whether a valuation allowance is
necessary.
22. (LO 3) What are the elements that define a tax planning
strategy as it applies to determining if a valuation allowance is
necessary? Provide an example where a tax planning strategy may be
necessary to avoid recording a valuation allowance.
ASC 740 defines a tax planning strategy as an action that is 1)
prudent and feasible, 2) is one that is not in the ordinary course
of business but which a company would take to prevent an operating
loss or tax credit carryforward from expiring unused, and 3) would
result in realization of the deferred tax assets. An example of a
tax planning strategy might be a companys willingness to sell a
parcel of land held for investment to create a capital gain that
could be used to keep a net capital loss carryover from expiring
unused. A company would have to rely on a tax planning strategy to
avoid recording a valuation allowance when the other three sources
of taxable income do not provide sufficient taxable income to
absorb the recorded deferred tax assets.
23. (LO 3) When does a company remove a valuation allowance from
its balance sheet?
A company removes a valuation allowance from its balance sheet
when it determines that it is more-likely-than-not that, based on
all available evidence, a deferred tax asset will be realized (that
is, the tax benefit will be received) in a future period.
24. (LO 3) What is a companys book equivalent of taxable income
and how does this computation enter into the income tax provision
process?
A company computes its book equivalent of taxable income by
adjusting pretax net income from continuing operations for
permanent differences. Multiplying the book equivalent of taxable
income by the applicable tax rate provides a back-of-the envelope
computation of the companys total income tax provision, assuming
there is no change in the companys applicable tax rate during the
period or other changes related to a prior period (for example, an
adjustment of a valuation allowance).
25. (LO 4) What motivated the FASB to issue FIN 48?
The FASB issued FIN 48 (now codified in ASC 740-10) because it
was concerned that there was diversity in practice in the way in
which companies computed their income tax contingency reserve under
FAS 5.
26. (LO 4) Briefly describe the two step process a company must
undertake when it evaluates whether it can record the tax benefit
from an uncertain tax position under ASC 740.
ASC 740-10 applies a two-step process to evaluating tax
positions. ASC 740 refers to the first step as recognition. A
company must determine whether it is more likely than not (a
greater than 50% probability) that a tax position will be sustained
on examination by the IRS or other taxing authority, including
resolution of any appeals at the court of last resort (the Supreme
Court in the United States), based on the technical merits of the
position.
The second step is referred to as measurement. If the tax
position meets the more-likely-than-not threshold (a subjective
determination), the company must determine the amount of the
benefit to record in the financial statements. The company records
the largest amount of the benefit, as calculated on a cumulative
probability basis, that is more-likely-than-not to be realized on
the ultimate settlement of the tax position. The portion not
recognized is referred to as an unrecognized tax benefit and is
recorded as an increase in income taxes payable on the balance
sheet.
27. (LO 4) Distinguish between recognition and measurement as
they relate to the computation of unrecognized tax benefits under
ASC 740.
Recognition is the process of determining whether the company
can record some portion or all of the tax benefit from the tax
position on its financial statements. Measurement is the process of
determining the amount of the tax benefit that can be recorded on
the financial statements.
28. (LO 4) What is a tax position as it relates to the
application of ASC 740 to uncertain tax positions?
ASC 740-10 defines a tax position as any issue dealing with
income taxes. ASC 740 pertains to tax positions taken on a current
or previously filed tax return or a tax position that will be taken
on a future tax return that is reflected in the financial
statements as a deferred tax asset or liability. A tax position
also relates to tax returns that the company has not filed in a tax
jurisdiction but could be required to file in the future on
audit.
29. (LO 4) True or False: A company determines its unrecognized
tax benefits with respect to a transaction only at the time the
transaction takes place; subsequent events are ignored.
Explain.
False. A company must reassess its balance in its unrecognized
tax benefit account when subsequent events occur (for example, the
issuance of regulations, rulings, court opinions) that might change
the companys assessment of whether a tax position will be sustained
on audit and litigation. As facts and circumstances change, a
company must reevaluate the tax benefit amount they expect to
realize in the future.
30. (LO 4) True or False: ASC 740 requires that a company treat
potential interest and penalties related to an unrecognized tax
benefit as part of its income tax provision. Explain.
False. ASC 740-10 allows a company to treat potential interest
and penalties related to an unrecognized tax benefit as part of its
income tax provision or as expenses deducted in the computation of
its pre-tax income or loss from continuing operations. ASC 740
requires that the company apply its election consistently from
period to period and disclose how it is treating the interest and
penalties in its financial statements in a footnote to the
financial statements (usually in the Income Taxes note). The
liability related to interest and penalties is not included in the
liability related to unrecognized tax benefits on the balance
sheet, however.
31. (LO 4) Where on the balance sheet does a company report its
unrecognized tax benefits?
A company reports its unrecognized tax benefits as part of its
income taxes payable or some other liability on the balance sheet.
The additional tax that the company expects to pay in the next 12
months is classified as current income taxes payable. The tax the
company expects to pay beyond the next 12 months is classified as
long-term income taxes payable.
32. (LO 4) Why did many companies oppose FIN 48 when it was
first proposed?
Opponents of FIN 48 worried that the FIN 48 disclosures would
provide a roadmap to the IRS to a companys uncertain tax positions.
The aggregate reporting of uncertain tax positions has provided the
IRS with less information than it may have expected, which led the
Treasury to create new Schedule UTP, on which a company is required
to list its uncertain tax positions taken on its financial
statements.
33. (LO 5) How does a company determine if a deferred tax asset
or liability should be classified as current or noncurrent on its
balance sheet?
A company classifies its deferred tax assets and liabilities
based on the classification of the asset or liability to which the
deferred tax account relates. Deferred tax liabilities related to a
long-term asset (for example, depreciation of a fixed asset) are
classified as noncurrent because the related asset is classified as
noncurrent on the balance sheet. A deferred tax asset related to
uncollectible accounts receivable would be classified as a current
asset because accounts receivable is treated as a current asset.
Deferred tax liabilities and assets not related to a specific asset
(for example, a net operating loss carryover or organizational
expenditures capitalized for tax purposes) are classified based on
the expected reversal date of the temporary difference.
34. (LO 5) Under what conditions can a company net its current
deferred tax assets with its current deferred tax liabilities on
the balance sheet?
ASC 740 permits netting of current deferred tax assets and
liabilities if they are attributable to the same tax jurisdiction
or relate to the same components of the enterprise (for example, a
subsidiary that is part of the consolidated financial statements
and part of the consolidated income tax return). The same netting
rule applies to noncurrent deferred tax assets and liabilities as
well.
35. (LO 5) True or False: A publicly traded company must
disclose all of the components of its deferred tax assets and
liabilities in a footnote to the financial statements. Explain.
False. ASC 740 states that a publicly traded company should
disclose the approximate tax effect of each type of temporary
difference and carryforward that gives rise to a significant
portion of net deferred tax liabilities and deferred tax assets. A
privately held company only needs to disclose the types of
significant temporary differences without disclosing the tax
effects of each type. ASC 740 does not define the term significant,
although the SEC requires a publicly traded company to disclose
separately the components of its total deferred tax assets and
liabilities that are 5% or more of the total balance.
36. (LO 5) What is a companys hypothetical income tax provision
and what is its importance in a companys disclosure of its income
tax provision in the tax footnote?
A companys hypothetical income tax provision is the income tax
provision or benefit that would result from applying the companys
U.S. statutory tax rate (34% or 35%) to its pretax income or loss
from continuing operations. The hypothetical income tax provision
is the amount that is reconciled with the companys actual income
tax provision or benefit in the effective tax rate reconciliation
component of the companys income taxes note to the financial
statements.
37. (LO 5) Briefly describe the difference between a companys
effective tax rate, cash tax rate, and structural tax rate.
The effective tax rate is the companys total income tax expense
or benefit divided by the companys pre-tax net income or loss from
continuing operations. The effective tax rate often serves as a
benchmark for companies in the same industry. A companys cash tax
rate is the effective tax rate taking into account only taxes
actually paid or refunded during the year. Taxes paid or refunded
usually is reported in the companys Statement of Cash Flows. A
companys structural tax rate is the effective tax rate adjusted for
one-time (discrete) and non-recurring book-tax differences. It is
usually interpreted as the companys sustainable effective tax rate
from operations.
Problems
38. (LO 1) Which of the following taxes is not accounted for
under ASC 740?a.Income taxes paid to the U.S. governmentb.Income
taxes paid to the French governmentc.Income taxes paid to the city
of Detroitd.Property taxes paid to the city of Detroite.All of the
above taxes are accounted for under ASC 740
d. Property taxes paid to the city of Detroit are not income
taxes because they are assessed based on value and not income.
39. (LO 1) Which of the following organizations can issue rules
that govern accounting for income taxes?a.FASBb.SECc.IRSd.a and b
abovee.All of the above organizations
d. Both the FASB and SEC can issue rules that govern accounting
for income taxes. Congress also can issue rules that govern
accounting for income taxes, but the IRS is restricted to writing
rules and procedures related to the federal income tax.
40. ([LO 1) Find the paragraph(s) in ASC 740 that deal with the
following items (you can access ASC 740 on the FASB website at
http://www.fasb.org, and clicking on View the Codification. You
will need a password from your instructor.a.The objectives and
basic principles that underlie ASC 740b.Examples of book-tax
differences that create temporary differencesc.The definition of a
tax planning strategyd.Examples of positive evidence in the
valuation allowance processe.Rules relating to financial statement
disclosure
a. ASC 740: 740-10-10-1b. 740-10-25-20c. 740-10-30-19d.
740-10-30-22e. 740-10-50
41. (LO 2) Woodward Corporation reported pre-tax book income of
$1,000,000. Included in the computation were favorable temporary
differences of $200,000, unfavorable temporary differences of
$50,000, and favorable permanent differences of $100,000. Assuming
a tax rate of 34%, compute the companys current income tax expense
or benefit.
Pre-tax book income$1,000,000Favorable temporary
differences(200,000)Unfavorable temporary
differences50,000Favorable permanent differences(100,000)Taxable
income750,000 34% 34%Current income tax expense$255,000
42. (LO 2) Cass Corporation reported pre-tax book income of
$10,000,000. During the current year, the reserve for bad debts
increased by $100,000. In addition, tax depreciation exceeded book
depreciation by $200,000. Cass Corporation sold a fixed asset and
reported book gain of $50,000 and tax gain of $75,000. Finally, the
company received $250,000 of tax-exempt life insurance proceeds
from the death of one of its officers. Assuming a tax rate of 34%,
compute the companys current income tax expense or benefit.
Pre-tax book income $10,000,000Increase in bad debt
reserve100,000Excess tax depreciation(200,000)Excess tax over book
gain25,000Tax-exempt life insurance proceeds (250,000)Taxable
income$9,675,000 34% 34%Current income tax expense$3,289,500
43. (LO 2) Grand Corporation reported pre-tax book income of
$600,000. Tax depreciation exceeded book depreciation by $400,000.
In addition, the company received $300,000 of tax-exempt municipal
bond interest. The companys prior year tax return showed taxable
income of $50,000. Assuming a tax rate of 34%, compute the companys
current income tax expense or benefit.
Pre-tax book income$600,000Excess tax
depreciation(400,000)Tax-exempt interest income (300,000)Net
operating loss$(100,000)
NOL carryback to prior year$50,000 34% 34%Current income tax
benefit$17,000
The remaining $50,000 NOL carryover will be recorded as a
deferred tax asset (benefit) of $17,000.
44. (LO 2) Chandler Corporation reported pre-tax book income of
$2,000,000. Tax depreciation exceeded book depreciation by
$500,000. During the year the Company capitalized $250,000 into
ending inventory under 263A. Capitalized inventory costs of
$150,000 in beginning inventory were deducted as part of cost of
goods sold on the tax return. Assuming a tax rate of 34%, compute
the companys taxes payable or refundable.
Pre-tax book income$2,000,000Excess tax
depreciation(500,000)Increase in capitalized inventory costs
100,000Taxable income$1,600,000 34% 34%Current income taxes
payable$544,000
45. (LO 2) Davison Company determined that the book basis of its
office building exceeded the tax basis by $800,000. This basis
difference is properly characterized as:a.Permanent
differenceb.Taxable temporary differencec.Deductible temporary
differenced.Favorable book-tax differencee.Both b and d above are
correct
e. Taxable temporary difference and favorable book-tax
difference. Future taxable income will increase by $800,000
compared to future book income as the excess book basis is
recovered, resulting in a future tax payable.
46. (LO 2) Abbot Company determined that the book basis of its
allowance for bad debts is $100,000. There is no corresponding tax
basis in this account. The basis difference is properly
characterized as:a.Permanent differenceb.Taxable temporary
differencec.Deductible temporary differenced.Favorable book-tax
differencee.Both b and d above are correct
c. Deductible temporary difference. Future taxable income will
decrease by $100,000 compared to future book income as the bad
debts are charged off, resulting in a future tax benefit.
47. (LO 2) Which of the following items is not a temporary
book-tax basis difference?a.Warranty reserve accrualsb.Accelerated
depreciationc.Capitalized inventory costs under 263Ad.Nondeductible
stock option compensation from exercising an ISOe.All of the above
are temporary differences
d. Nondeductible stock option compensation from exercising an
ISO (incentive stock option). A company does not receive a tax
deduction when an employee exercises an incentive stock option,
making the book stock compensation deduction a permanent
difference.
48. (LO 2) Which of the following book-tax differences does not
create a favorable temporary book-tax basis difference?a.Tax
depreciation for the period exceeds book depreciationb.Bad debts
charged off in the current period exceed the bad debts accrued in
the current periodc.Inventory costs capitalized under 263A deducted
as part of current year tax cost of goods sold are less than the
inventory costs capitalized in ending inventoryd.Vacation pay
accrued for tax purposes in a prior period is deducted in the
current periode.All of the above create a favorable temporary
book/tax temporary difference
c. Inventory costs capitalized under 263A deducted as part of
current year tax cost of goods sold are less than the inventory
costs capitalized in ending inventory. In this case, book income
would exceed taxable income, creating an unfavorable book-tax
difference.
49. (LO 2) Lodge, Inc. reported pre-tax book income of
$5,000,000. During the year, the company increased its reserve for
warranties by $200,000. The company deducted $50,000 on its tax
return related to warranty payments made during the year. What is
the impact on taxable income compared to pre-tax book income of the
book-tax difference that results from these two events?a.Favorable
(decreases taxable income)b.Unfavorable (increases taxable
income)c.Neutral (no impact on taxable income)
b Unfavorable (increases taxable income). Book income would be
$150,000 less than taxable income in the current year.
50. (LO 2) Which of the following book-tax basis differences
results in a deductible temporary difference?a.Book basis of a
fixed asset exceeds its tax basisb.Book basis of a pension-related
liability exceeds its tax basisc.Prepayment of income included on
the tax return but not on the income statement (the transaction is
recorded as a liability on the balance sheet)d.All of the above
result in a deductible temporary differencee.Both b and c result in
a deductible temporary difference
e. The future payment of the accrued pension liability and the
future recording of previously recorded taxable income will result
in future taxable income being less than book income, resulting in
a future tax benefit.
51. (LO 2) Shaw Corporation reported pre-tax book income of
$1,000,000. Included in the computation were favorable temporary
differences of $200,000, unfavorable temporary differences of
$50,000, and favorable permanent differences of $100,000. Assuming
a tax rate of 34%, compute the companys deferred income tax expense
or benefit.
Favorable temporary differences$(200,000)Unfavorable temporary
differences 50,000Net increase in favorable temporary
diff.$(150,000) 34% 34%Net increase in deferred income tax
liability$ (51,000)
The net increase in the deferred income tax liability is
recorded as the companys deferred tax expense in the current year.
Permanent differences do not affect the deferred income tax
provision.
52. (LO 2) Shaw, Inc. reported pre-tax book income of
$10,000,000. During the current year, the reserve for bad debts
increased by $100,000. In addition, tax depreciation exceeded book
depreciation by $200,000. Shaw, Inc. sold a fixed asset and
reported book gain of $50,000 and tax gain of $75,000. Finally, the
company received $250,000 of tax-exempt life insurance proceeds
from the death of one of its officers. Assuming a tax rate of 34%,
compute the companys deferred income tax expense or benefit.
Increase in bad debt reserve$100,000Excess tax
depreciation(200,000)Excess tax gain 25,000Net increase in
favorable temporary diff.$ (75,000) 34% 34%Net increase in deferred
income tax liability$ (25,500)
The net increase in the deferred income tax liability is
recorded as the companys deferred tax expense in the current year.
Permanent differences do not affect the deferred tax provision.
53. (LO 2) Harrison Corporation reported pre-tax book income of
$600,000. Tax depreciation exceeded book depreciation by $400,000.
In addition, the company received $300,000 of tax-exempt municipal
bond interest. The companys prior year tax return showed taxable
income of $50,000. Assuming a tax rate of 34%, compute the companys
deferred income tax expense or benefit.
Pre-tax book income $600,000Excess tax
depreciation(400,000)Tax-exempt interest income (300,000)Net
operating loss$(100,000)
NOL carryback to prior year$50,000 34% 34%Current income tax
refundable$17,000
Excess tax depreciation(400,000)NOL carryover to 2014 50,000Net
increase in favorable temporary diff.$(350,000) 34% 34%Net increase
in deferred income tax liability$(119,000)
The net increase in the deferred income tax liability is
recorded as the companys deferred tax expense in the current year.
This assumes the company does not record a valuation against the
deferred tax asset created by the NOL carryover. Permanent
differences do not affect the deferred tax provision.
54. (LO 2) Identify the following items as creating a temporary
difference, permanent difference, or no difference.
ItemTemporary DifferencePermanent DifferenceNo Difference
Reserve for warrantiesX
Accrued pension liabilityX
Goodwill not amortized for tax purposes but subject to
impairment under ASC 350X
Meal and entertainment expensesX
Life insurance proceedsX
Net capital loss carryoverX
Nondeductible fines and penaltiesX
Accrued vacation pay liability paid within the first 2 months of
the next tax yearX
55. (LO 2) Which of the following items is not a permanent
book/tax difference?a.Tax-exempt interest incomeb.Tax-exempt
insurance proceedsc.Domestic production activities
deductiond.Non-deductible meals and entertainment
expensee.First-year expensing under 179
e. First year expensing under 179. First year expensing will
eventually be recovered as book depreciation.
56. (LO 2) Ann Corporation reported pre-tax book income of
$1,000,000. Included in the computation were favorable temporary
differences of $200,000, unfavorable temporary differences of
$50,000, and favorable permanent differences of $100,000. Compute
the Companys book equivalent of taxable income. Use this number to
compute the Companys total income tax provision or benefit,
assuming a tax rate of 34%.
Pre-tax book income$1,000,000Favorable permanent
differences(100,000)Book equivalent of taxable income900,000 34%
34%Total income tax provision$306,000
Book equivalent of taxable income takes into account only
permanent differences.
57. (LO 2) Burcham Corporation reported pre-tax book income of
$600,000. Tax depreciation exceeded book depreciation by $400,000.
In addition, the Company received $300,000 of tax-exempt municipal
bond interest. The Companys prior year tax return showed taxable
income of $50,000. Compute the Companys book equivalent of taxable
income. Use this number to compute the Companys total income tax
provision or benefit, assuming a tax rate of 34%.
Pre-tax book income$600,000Tax-exempt interest(300,000)Book
equivalent of taxable income300,000 34% 34%Total income tax
provision$102,000
Book equivalent of taxable income takes into account only
permanent differences.
58. (LO 3) Adams Corporation has total deferred tax assets of
$3,000,000 at year-end. Management is assessing whether a valuation
allowance must be recorded against some or all of the deferred tax
assets. What level of assurance must management have, based on the
weight of available evidence, that some or all of the deferred tax
assets will not be realized before a valuation allowance is
required?a.Probableb.More likely than notc.Realistic
possibilityd.Reasonablee.More than remote
b.More likely than not
59. (LO 3) Which of the following evidence would not be
considered positive in determining whether Adams Corporation needs
to record a valuation allowance for some or all of its deferred tax
assets?a.The Company forecasts future taxable income because of its
backlog of ordersb.The Company has unfavorable temporary
differences that will create future .taxable income when they
reverse.c.The Company has tax planning strategies that it can
implement to create future taxable income.d.The Company has
cumulative net income over the current and prior two years.e.The
Company had a net operating loss carryover expire in the current
year.
e. The Company had a net operating loss carryover expire in the
current year. ASC 740 lists the expiration of tax carryovers as a
source of negative evidence.
60. (LO 3) As of the beginning of the year, Gratiot Company
recorded a valuation allowance of $200,000 against its deferred tax
assets of $1,000,000. The valuation allowance relates to a net
operating loss carryover from the prior year. During the year,
management concludes that the valuation allowance is no longer
necessary because it forecasts sufficient taxable income to absorb
the NOL carryover. What is the impact of managements reversal of
the valuation allowance on the companys effective tax
rate?a.Increases the ETRb.Decreases the ETRc.No impact on the
ETR
b. Decreases the ETR. Removing the valuation allowance creates
an increase in the companys income tax benefit, which is treated as
a prior period adjustment and causes the effective tax rate to
decrease.
61. (LO 3) Which of the following evidence would be considered
negative in determining whether Gratiot Corporation needs to record
a valuation allowance for some or all of its deferred tax
assets?a.The company forecasts future taxable income because of its
backlog of orders.b.The company has a cumulative net loss over the
current and prior two years.c.The company has unfavorable temporary
differences that will create future taxable income when they
reverse.d.The company had a net operating loss carryover expire in
the current year.e.Both b and d constitute negative evidence in
assessing the need for a valuation allowance.
e. Both b and d constitute negative evidence in assessing the
need for a valuation allowance. ASC 740 states that cumulative book
losses constitute a source of negative evidence, as does the
expiration of a net operating loss carryover.
62. (LO 3) Saginaw, Inc. completed its first year of operations
with a pre-tax loss of $500,000. The tax return showed a net
operating loss of $600,000, which the Company will carry forward.
The $100,000 book-tax difference results from excess tax
depreciation over book depreciation. Management has determined that
they should record a valuation allowance equal to the net deferred
tax asset. Assuming the current tax expense is zero, prepare the
journal entries to record the deferred tax provision and the
valuation allowance.
Deferred tax asset*204,000Deferred tax benefit204,000*$600,000
34%
Deferred tax expense 34,000Deferred tax liability*
34,000*$100,000 34%
Deferred tax benefit*170,000Valuation
allowance170,000*$($600,000 - $100,000) 34%
63. (LO3) Access Ford Motor Companys Annual Report for 2011 from
the companys website (www.ford.com). What amount of valuation
allowance against its deferred tax assets did the company release
in 2011? What reasons did management give for releasing the
valuation allowance? (Hint: Read Managements Discussion and
Analysis and the Income Taxes footnote.) What impact, if any, did
release of the valuation allowance have on the companys effective
tax rate for 2011? Why did the valuation allowance release affect
(not affect) the companys ETR?
Ford Motor Co. reduced its valuation allowance from $15,664
million in 2010 to $1,545 million in 2011.Management gave the
following reasons for reducing the valuation allowance in its
Discussion and Analysis:
At December 31, 2010, our valuation allowance was $15.7 billion,
leaving net deferred tax assets of about $900 million on our
balance sheet. Prior to year-end 2011, the pattern of
objectively-measured negative evidence of recent financial
reporting losses outweighed the positive evidence of our growing
profitability, despite the tangible progress we were making in
implementing our One Ford plan. By the end of 2011, our U.S.
operations had returned to a position of cumulative profits for the
most recent three-year period. We concluded that this record of
cumulative profitability in recent years, our ten consecutive
quarters of pre-tax operating profits, our successful completion of
labor negotiations with the UAW, and our business plan showing
continued profitability, provided assurance that our future tax
benefits more likely than not will be realized. Accordingly, at
year-end 2011, we released almost all of our valuation allowance
against net deferred tax assets for entities in the United States,
Canada, and Spain, resulting in a $12.4 billion benefit in our
provision for income taxes.
The reduction in the valuation allowance reduced Fords effective
tax rate by 172.3 percentage points! This percentage point decrease
is computed by dividing the reduction in the valuation allowance of
$14,119 million by pretax income of $8,181 million. The reduction
in the valuation allowance impacts the current period effective tax
rate because it is a prior period adjustment that runs through
continuing operations for income tax accounting purposes.
64. (LO 4) Montcalm Corporation has total deferred tax assets of
$3,000,000 at year-end. Of that amount, $1,000,000 results from the
current expensing of an expenditure that the IRS might assert must
be capitalized on audit. Management is trying to determine if it
should not recognize the deferred tax asset related to this item
under ASC 740. What confidence level must management have that the
item will be sustained on audit before it can recognize any portion
of the deferred tax asset under ASC 740?a.Probableb.More likely
than notc.Realistic possibilityd.Reasonablee.More than remote
b. More likely than not
65. (LO 4) Which of the following statements about uncertain tax
positions (UTP) is correct?a.UTP applies only to tax positions
accounted for under ASC 740 taken on a filed tax return.b.UTP
applies to all tax positions accounted for under ASC 740,
regardless of whether the item is taken on a filed tax return.c.UTP
deals with both the recognition and realization of deferred tax
assets.d.If a tax position meets the more likely than not standard,
the entire amount of the deferred tax asset or current tax benefit
related to the tax position can be recognized under ASC
740.e.Statements b, c, and d are correct.
b. UTP applies to all tax positions accounted for under ASC 740,
regardless of whether the item is taken on a filed tax return.
66. (LO 4) Cadillac Square Corporation determined that
$1,000,000 of its domestic production activities deduction on its
current year tax return was uncertain, but that it was more likely
than not to be sustained on audit. Management made the following
assessment of the Companys potential tax benefit from the deduction
and its probability of occurring.
Potential Estimated Individual Probability Cumulative
Probability Benefit (000s) of Occurring (%) of Occurring $340,000
40 40 272,000 25 65 170,000 20 85 0 15 100
What amount of the tax benefit related to the uncertain tax
position from the DPAD can Cadillac Square Corporation recognize in
calculating its income tax provision in the current year?
$272,000, the amount that has a cumulative probability of more
than 50% of occurring. Cadillac Square Corporation would record an
increase in its income taxes payable (income tax expense) of
$68,000, the difference between the full benefit received on the
tax return and the expected benefit to be received after audit by
the IRS.
67. (LO 4) How would your answer to Question 66 change if
management determined that there was only a 50/50 chance any
portion of the $1,000,000 domestic production activity deduction
(DPAD) would be sustained on audit?
No amount of the tax benefit from the deduction could be
recognized. The recognition threshold has not been met (more likely
than not), and therefore, the measurement step is not taken.
Cadillac Square Corporation would record an increase in its income
taxes payable (income tax expense) of $340,000, the full benefit
received on the tax return.
68. (LO 4) As part of its UTP assessment, Penobscot Company
records interest and penalties related to its tax contingency
amount of $500,000. Which of the following statements about
recording this amount is most correct?a.Penobscot must include the
amount in its income tax provisionb.Penobscot must record the
amount separate from its income tax provisionc.Penobscot can elect
to allocate a portion of the amount to both its income tax
provision and its general and administrative expenses provided the
company discloses which option it chosed.Penobscot can elect to
record the entire amount as part of its income tax provision or
separate from its income tax provision, provided the company
discloses which option it chosee.Statements c and d are both
correct
d. Penobscot can elect to record the entire amount as part of
its income tax provision or separate from its income tax provision
as a pre-tax operating expense, provided the Company discloses
which option it is using.
69. (LO5) What was IBMs accounting effective tax rate for 2011?
What items caused the companys accounting effective tax rate to
differ from the hypothetical tax rate of 35%? What was the companys
cash effective tax rate for 2011? What factors cause a companys
cash tax rate to differ from its accounting effective tax rate? You
can access IBMs annual report for 2011 at http://www.ibm.com.
IBMs accounting effective tax rate for 2011 was 24.5%
($5,148/$21,003).
IBM reports that its effective tax rate decreased 10 percentage
points from the foreign tax rate differential, increased 2
percentage points from state and local taxes, and decreased 2
percentage points by other.
IBMs cash effective tax rate for 2011 was 19.8%
($4,168/$21,003).
The cash effective tax rate can differ from the accounting
effective tax rate because of additional taxes or refunds received
from audits of prior year tax returns and from the tax benefits
related to the exercise of nonqualified stock options.
70. (LO 5) Beacon Corporation recorded the following deferred
tax assets and liabilities:
Current deferred tax assets$650,000Current deferred tax
liabilities(400,000)Non-current deferred tax
assets1,000,000Non-current deferred tax liabilities(2,500,000) Net
deferred tax liabilities$(1,250,000)
All of the deferred tax accounts relate to temporary differences
that arose as a result of the companys U.S. operations. Which of
the following statements describes how Beacon should disclose these
accounts on its balance sheet?a.Beacon reports a net deferred tax
liability of $1,250,000 on its balance sheetb.Beacon nets the
deferred tax assets and the deferred tax liabilities and reports a
net deferred tax asset of $1,650,000 and a net deferred tax
liability of $2,900,000 on its balance sheet.c.Beacon can elect to
net the current deferred tax accounts and the non-current tax
accounts and report a net current deferred tax asset of $250,000
and a net deferred tax liability of $1,500,000 on its balance
sheet.d.Beacon is required to net the current deferred tax accounts
and the non-current tax accounts and report a net current deferred
tax asset of $250,000 and a net deferred tax liability of
$1,500,000 on its balance sheet.
d. Beacon is required to net the current deferred tax accounts
and the non-current tax accounts and report a net current deferred
tax asset of $250,000 and a net deferred tax liability of
$1,500,000 on its balance sheet. The netting is required because
the deferred tax accounts all arose in the same tax jurisdiction
(ASC 740-10-45-6).
71. (LO 5) ASC requires a company to disclose those components
of its deferred tax assets and liabilities that are
considereda.Relevantb.Significantc.Importantd.Major
b. Significant
72. (LO 5) Which of the following temporary differences creates
a current deferred tax asset?a.Allowance for bad debtsb.Goodwill
amortizationc.Accumulated depreciationd.Inventory capitalization
under 263Ae.Both a and d create a current deferred tax asset
e. Both a and d create a current deferred tax asset. Deferred
tax accounts are classified based on the balance sheet
classification of the item to which they relate. Accounts
receivable and inventory are both classified as current assets.
73. (LO 5) Which formula represents the calculation of a
companys effective tax rate?a.Income taxes paid / Taxable
incomeb.Income taxes paid / Pre-tax income from continuing
operationsc.Income tax provision / Taxable incomed.Income tax
provision / Pre-tax income from continuing operations
d. Income tax provision / Pre-tax income from continuing
operations
74. (LO 5) Which of the following items is not a reconciling
item in the income tax footnote?a.State income taxesb.Foreign
income taxesc.Accrued pension liabilitiesd.Dividends received
deductione.Tax exempt municipal bond interest
c. Accrued pension liabilities. Accrued pension liabilities is a
temporary difference and does not appear in the effective tax rate
reconciliation unless the company makes an adjustment to the
account that relates to a prior period.
75. (LO 5) Randolph Company reported pre-tax net income from
continuing operations of $800,000 and taxable income of $500,000.
The book-tax difference of $300,000 was due to a $200,000 favorable
temporary difference relating to depreciation, an unfavorable
temporary difference of $80,000 due to an increase in the reserve
for bad debts, and a $180,000 favorable permanent difference from
the receipt of life insurance proceeds. Randolph Companys
applicable tax rate is 34%.
a.Compute Randolph Companys current income tax expense.b.Compute
Randolph Companys deferred income tax expense or benefit.c.Compute
Randolph Companys effective tax rate.d.Provide a reconciliation of
Randolph Companys effective tax rate with its hypothetical tax rate
of 34%.
a.Pre-tax net income$800,000Favorable temporary
difference(200,000)Unfavorable temporary difference80,000Favorable
permanent difference(180,000)Taxable income500,000 34% 34%Current
income tax payable$170,000
b.Favorable temporary difference (200,000)Unfavorable temporary
differences 80,000Net favorable temporary difference(120,000) 34%
34%Deferred tax expense (liability)$(40,800)
Total income tax provision = $170,000 + $40,800 = $210,800
Effective tax rate = $210,800 / $800,000 = 26.35%
c.ETR reconciliation Income tax expense at 34%
(hypothetical)*$272,000 Tax benefit from permanent difference**(
61,200) Income tax provision$210,800 *$800,000 x 34% **$180,000 x
34%
d. Hypothetical income tax rate34.00% Tax benefit from permanent
difference*(7.65%) Effective tax rate26.35% *$61,200 / $800,000
76. (LO 5) Which of the following pronouncements should a
company consult in computing its quarterly income tax
provision?a.ASC 740b.ASC 230c.ASC 718d.ASC 810 e.SarbOX 404
a. ASC 740
Comprehensive Problems
77. You have been assigned to compute the income tax provision
for Motown Memories, Inc. (MM) as of December 31, 2013. The
Companys federal income tax rate is 34%. The Companys Income
Statement for 2013 is provided below:
Motown Memories, Inc.
Statement of Operations
at December 31, 2013
Net sales$50,000,000
Cost of sales28,000,000
Gross profit22,000,000
Compensation2,000,000
Selling expenses1,500,000
Depreciation and amortization4,000,000
Other expenses 500,000
Total operating expenses8,000,000
Income from operations$14,000,000
Interest and other income1,000,000
Income before income taxes$15,000,000
You have identified the following permanent differences:
Interest income from municipal bonds: $50,000 Nondeductible meals
and entertainment expenses: $20,000 Domestic production activities
deduction: $250,000 Nondeductible fines: $5,000
MM prepared the following schedule of temporary differences from
the beginning of the year to the end of the year:
Motown Memories, Inc.
Temporary Difference Scheduling Template
BOYBeginningCurrentEOYEnding
Taxable (Favorable)CumulativeDeferredYearCumulativeDeferred
Temporary DifferencesT/DTaxes (@ 34%)ChangeT/DTaxes (@ 34%)
Non-current
Accumulated
depreciation(8,000,000)(2,720,000)(1,000,000)(9,000,000)(3,060,000)
BOYBeginningCurrentEOYEnding
Deductible
(Unfavorable)CumulativeDeferredYearCumulativeDeferred
Temporary DifferencesT/DTaxes (@ 34%)ChangeT/DTaxes (@ 34%)
Current
Allowance for bad debts200,00068,00050,000250,00085,000
Reserve for warranties100,00034,00020,000120,00040,800
Inventory 263A adjustment240,00081,60060,000300,000102,000
Total current540,000183,600130,000670,000227,800
Non-Current
Deferred compensation50,00017,00010,00060,00020,400
Accrued pension
liabilities3,000,0001,020,000250,0003,250,0001,105,000
Total non-current3,050,0001,037,000260,0003,310,0001,125,400
Total3,590,0001,220,600390,0003,980,0001,353,200
a.Compute MMs current income tax expense or benefit for
2013.b.Compute MMs deferred income tax expense or benefit for
2013.c.Prepare a reconciliation of MMs total income tax provision
with its hypothetical income tax expense in both dollars and
rates.
See attached spreadsheet solutions.
78. You have been assigned to compute the income tax provision
for Tulip City Flowers, Inc. (TCF) as of December 31, 2013. The
Companys federal income tax rate is 34%. The Companys Income
Statement for 2013 is provided below:
Tulip City Flowers, Inc.
Statement of Operations
at December 31, 2013
Net sales$20,000,000
Cost of sales12,000,000
Gross profit8,000,000
Compensation500,000
Selling expenses750,000
Depreciation and amortization1,250,000
Other expenses1,000,000
Total operating expenses3,500,000
Income from operations$4,500,000
Interest and other income 25,000
Income before income taxes$4,525,000
You have identified the following permanent differences:
Interest income from municipal bonds: $10,000 Nondeductible stock
compensation: $5,000 Domestic production activities deduction:
$8,000 Nondeductible fines: $1,000
TCF prepared the following schedule of temporary differences
from the beginning of the year to the end of the year:
Tulip City Flowers, Inc.
Temporary Difference Scheduling Template
BOYBeginningCurrentEOYEnding
Taxable (Favorable)CumulativeDeferredYearCumulativeDeferred
Temporary DifferencesT/DTaxes (@ 34%)ChangeT/DTaxes (@ 34%)
Non-current
Accumulated
depreciation(5,000,000)(1,700,000)(500,000)(5,500,000)(1,870,000)
BOYBeginningCurrentEOYEnding
Deductible
(Unfavorable)CumulativeDeferredYearCumulativeDeferred
Temporary DifferencesT/DTaxes (@ 34%)ChangeT/DTaxes (@ 34%)
Current
Allowance for bad debts100,00034,00010,000110,00037,400
Prepaid income0020,00020,0006,800
Total current100,00034,00030,000130,00044,200
Non-Current
Deferred compensation50,00017,00010,00060,00020,400
Accrued pension
liabilities500,000170,000100,000600,000204,000
Total non-current550,000187,000110,000660,000224,400
Total650,000221,000140,000790,000268,600
a.Compute TCFs current income tax expense or benefit for
2013.b.Compute TCFs deferred income tax expense or benefit for
2013.c.Prepare a reconciliation of TCFs total income tax provision
with its hypothetical income tax expense in both dollars and
rates.d.Assume TCFs tax rate increased to 35% in 2013. Recompute
TCFs deferred income tax expense or benefit for 2013 using the
following template:
Tulip City Flowers, Inc.
Temporary Difference Scheduling Template
BOYBeginningCurrentEOYEnding
Taxable (Favorable)CumulativeDeferredYearCumulativeDeferred
Temporary DifferencesT/DTaxes (@ 34%)ChangeT/DTaxes (@ 35%)
Non-current
Accumulated
depreciation(5,000,000)(1,700,000)(500,000)(5,500,000)
BOYBeginningCurrentEOYEnding
Deductible
(Unfavorable)CumulativeDeferredYearCumulativeDeferred
Temporary DifferencesT/DTaxes (@ 34%)ChangeT/DTaxes (@ 35%)
Current
Allowance for bad debts100,00034,00010,000110,000
Prepaid income0020,00020,000
Total current100,00034,00030,000130,000
Non-Current
Deferred compensation50,00017,00010,00060,000
Accrued pension liabilities500,000170,000100,000600,000
Total non-current550,000187,000110,000660,000
Total650,000221,000140,000790,000
See attached spreadsheet solutions.
79. Access the 2011 Annual Report for Google and answer the
following questions. You can access the annual report at
http://www.google.com.
a. Using information from the companys Income Statement and
Income Taxes footnote, what was the companys effective tax rate for
2011? Show how the rate is calculated.
The company reports an effective tax rate of 21% for 2011,
computed as $2,589 / $12,326.
b. Using information from the Statement of Cash Flows, calculate
the companys cash tax rate.
The companys cash tax rate for 2011 was 11.9%, computed as
$1,471 / $12,326.
c. What does the companys Income Taxes note tell you about where
the company earns its international income? Why does earning income
in these countries cause the effective tax rate to decrease?
In the Income Taxes note (Note 15), the company informs
investors that substantially all of the income from foreign
operations was earned by an Irish subsidiary. Earning income in
Ireland causes the companys effective tax rate to decrease because
Ireland taxes income at a tax rate of 12.5%, which is significantly
lower than the U.S. rate of 35%. Under U.S. tax laws, the income
earned in these countries is not subject to U.S. tax until
repatriated to the United States. For an interesting discussion of
Googles international operations, see Jesse Drucker, The Tax Haven
Thats Saving Google Billions, Businessweek, October 21, 2010.
d. What item creates the companys largest deferred tax asset?
Explain why this item creates a deductible temporary
difference.
The companys largest deferred tax asset relates to Stock-based
compensation expense. The temporary difference results because the
company accrues stock-based compensation under ASC 718 but cannot
deduct the expense for tax purposes until the employees exercise
the stock options or earn the right to receive the stock.
e. What item creates the companys largest deferred tax
liability? Explain why this item creates a taxable temporary
difference.
Depreciation and amortization. The temporary difference results
because the company depreciates and amortizes its assets for tax
purposes using a more accelerated method than for financial
accounting purposes. This creates a taxable temporary difference
that will result in a future tax liability when the book
depreciation begins to exceed the tax depreciation in future
periods.
f. How does the company classify its unrecognized tax benefits
on the balance sheet?
The company does not specifically state in its Income Taxes note
how it classifies liabilities for unrecognized tax benefits.
However, the company lists non-current Income Taxes Payable on the
balance sheet at $1,693 million, which is close to the $1,564
million of unrecognized tax benefits identified in the Income Taxes
note.
g. How does the company treat interest and penalties related to
its unrecognized tax benefits?
The company states in its Income Taxes note that it classifies
interest and penalties related to its unrecognized tax benefits as
part of its income tax provision.
80. Spartan Builders Corporation is a builder of high end
housing with locations in major metropolitan areas throughout the
Midwest. At June 30, 2013, the company has deferred tax assets
totaling $10 million and deferred tax liabilities of $5 million,
all of which relate to U.S. temporary differences. Reversing
taxable temporary differences and taxable income in the carryback
period can be used to support approximately $2 million of the $10
million gross deferred tax asset. The remaining $8 million of gross
deferred tax assets will have to come from future taxable
income.
The company has historically been profitable. However,
significant loses were incurred in fiscal years 2011 and 2012.
These two years reflect a cumulative loss of 10 million, with
losses of $3 million expected in 2013. $7 million of the losses was
due to a write-down of inventory. Beginning in fiscal 2014,
management decided to get out of the metropolitan Chicago market,
which had become over-saturated with new houses.
Evaluate the companys need to record a valuation allowance for
the $10 million of gross deferred tax assets . What positive and
negative evidence would you weigh?
Positive evidence: The reversing taxable temporary differences
and taxable income in the carryback period is objective information
and supports $2 million of deferred tax assets. In addition, the
company has historically been profitable. Subjective positive
evidence is managements decision to leave an unprofitable market
and concentrate on profitable markets.
Negative evidence: The company will have cumulative book loss of
$13 million over three years at the end of 2013. ASC 740 states
that cumulative losses is negative evidence that is difficult to
overcome. Even if the write-down of inventory is excluded from the
computation because it is an aberration, there still is a
cumulative loss of $6 million over the current and prior two
years.
It appears the objective negative evidence outweighs the
subjective positive evidence, and the company should consider
recording a valuation allowance for the remaining $8 million of
deferred tax assets.
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