Check my work 5 Exercise 1624 Multiple temporary differences

Check my work 5 Exercise 16-24 Multiple temporary differences; balance sheet presentation [L016-4,16-5,16-6,16-8] 3 points At December 31, DePaul Corporation had a $16 million balance in its deferred tax asset account and a $142 million balance in its deferred tax liability account. The balances were due to the following cumulative temporary differences: 1. Estimated warranty expense, $20 million: expense recorded in the year of the sale; tax-deductible when paid (one-year warranty) 2. Depreciation expense, $230 million: straight-line in the income statement; MACRS on the tax return. 3. Income from installment sales of properties, $125 million: income recorded in the year of the sale; taxable when received equally Book Hint Print References over the next five years. 4. Rent revenue collected in advance, $20 million; taxable in the year collected; recorded as income when the performance obligation is satisfied in the following year. Assuming DePaul will show a single noncurrent net amount in its December 31 balance sheet, indicate that amount and whether it is a net deferred tax asset or liability. The tax rate is 40%. Determine the deferred tax amounts to be reported in the December 31 balance sheet. The tax rate is 40%. (Enter your answers in millions.) t deferred tax liability million

Solution

Let us take an example of company XYZ which produces mobile phones. The company XYZ assumes that the probability of a mobile phone being sent for warranty repairs is 2%. If XYZ’s revenue for financial year 2015 is Rs.10,00,000, then the following discrepancy arises in the income statement and the tax authority statement.

In the example above, the difference obtained between the two taxes payable is the deferred tax asset. The deferred tax asset in this case is (Rs.3,00,000 – Rs.2,94,000) = Rs.6,000.

Deferred tax liability arises when there is a difference between what a company can deduct as tax and the tax that is there for accounting purposes. A deferred tax liability signifies that a company may in future pay more income tax because of a transaction in the present.

Listed below are a few reasons which result into deferred tax liability arising for a company.

Let us take an example of the same company XYZ which produces mobile phones. The company XYZ assumes that a manufacturing machine that costs Rs.60,000 will last for 3 years and it pays a 30% tax on profits. However, regular financial accounting will take into account the Rs.20,000 depreciation per year for the next 3 years. Hence, each year income is reduced by Rs.20,000 and Rs.6,000 reduction in tax.

However, suppose the tax accounting allows depreciation in such a way that Rs.30,000 is the depreciation in the first year, Rs.20,000 in the next and Rs.10,000 in the third year. So for the first year, company can claim Rs.30,000 as depreciation and it gets a tax benefit of Rs.9000.

Although in doing so it creates a tax liability of:

Rs.9,000 – Rs.6,000 which is,

(tax that the company should have paid on the basis of accounting) – (the tax that it actually paid). Here, in this example a deferred tax liability of Rs.3,000 has been created. This liability, the company will have to make up for in its future transactions pertaining to taxes.

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Revenue	10,00,000
Warranty Expense	20,000
Taxable Income	9,80,000
Taxes Payable (at 30%)	2,94,000