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I. International Financial Reporting Standards (IFRS)

I. International Financial Reporting Standards (IFRS)

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Module 14: Deferred Taxes



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5. The liability method requires an entity to identify all temporary differences. The differences are then classified

as those giving rise to deferred tax liabilities, and those giving rise to deferred tax assets.







a. This distinction is important because all deferred tax liabilities are reported, whereas deferred tax assets can

only be recognized if it is probable (more likely than not) that the asset will be realized.

b. Similar to US GAAP, tax expense is the sum of current tax expense and the deferred tax expense.

















6. One of the significant differences in accounting for income taxes between US GAAP and IFRS is the

classification of deferred taxes on the balance sheet.

a. Recall that for US GAAP, the netting procedures involve netting current deferred tax assets (DTA) with

current deferred tax liabilities (DTL) to present one amount, and netting noncurrent DTA with noncurrent

DTL to present another amount.

b. Under IFRS, deferred tax assets and liabilities may not be classified as current.

c. The netting rules are also different.

(1) Netting of the components of deferred taxes is only permissible in certain situations.









(a) The rules for presentation and disclosure require that a current tax payable and a current tax

recoverable (receivable) can be offset only if it relates to the same taxing authority.

(b) Likewise, the netting of deferred tax assets and deferred tax liabilities must relate to the same

taxing authority. Therefore, in order to net these amounts, the entity must have a legal right to offset

the amounts, and the amounts must relate to the same taxing authority.

NOW REVIEW MULTIPLE-CHOICE QUESTIONS 42 THROUGH 44



KEY TERMS

Asset. A “probable future economic benefit obtained or controlled by a particular entity as a result of past transactions

or events” (SFAC 6).

Current tax expense or benefit. “The amount of income taxes paid or payable (or refundable) for a year as determined by applying the provisions of the tax law to the taxable income or excess of deductions over revenues for that year”

(ASC Topic 740).

Deferred tax asset. The deferred tax consequences attributable to deductible temporary differences and carryforwards.

Deferred tax expense or benefit. “The change during the year in an enterprise’s deferred tax liabilities or assets”

(ASC Topic 740).

Deferred tax liability. An amount that is recognized for the deferred tax consequence of temporary differences that

will result in taxable amounts in future years.

Liability. A “probable futures sacrifices of economic benefits arising from present obligations” (SFAC 6).

Loss carrybacks. Occur when losses in the current period are carried back to periods in which there was income.

Tax loss carryforwards. Occurs when losses in the current period are carried forward to future years.

Temporary difference. “A difference between the tax basis of an asset or liability and its reported amount in the financial statements that will result in taxable or deductible amounts in future years when the reported amount of the asset or

liability is recovered or settled, respectively.”



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Multiple-Choice Questions (1–44)

A.  Overview of Deferred Tax Theory







1. Justification for the method of determining periodic

deferred tax expense is based on the concept of

















C.  Deferred Tax Assets and Liabilities



a.

b.

c.

d.



Matching of periodic expense to periodic revenue.

Objectivity in the calculation of periodic expense.

Recognition of assets and liabilities.

Consistency of tax expense measurements with actual

tax planning strategies.



B.  Permanent and Temporary

Differences Defined



6. Dunn Co.’s year 1 income statement reported $90,000

income before provision for income taxes. To compute the

provision for federal income taxes, the following year 1 data

are provided:

Rent received in advance

Income from exempt municipal bonds

Depreciation deducted for income tax purposes

in excess of depreciation reported for financial

statements purposes

Enacted corporate income tax rate



2. Among the items reported on Cord, Inc.’s income statement

for the year ended December 31, year 1, were the following:

Payment of penalty

Insurance premium on life of an officer

with Cord as owner and beneficiary



$ 5,000

10,000



a.$0

b.$5,000

c.$10,000

d.$15,000



3. Caleb Corporation has three financial statement elements

for which the December 31, year 1 book value is different than

the December 31, year 1 tax basis.



Equipment

Prepaid officers

insurance policy

Warranty liability



Book

value

$200,000

  75,000



Tax basis



Difference



$120,000

0



$80,000

 75,000



  50,000



0



 50,000













a.$50,000

b.$80,000

c.$155,000

d.$205,000



a.

b.

c.

d.



Before they are

recognized in

financial income

Yes

No

No

Yes



5. Which of the following differences would result in future

taxable amounts?







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a.$18,000

b.$22,800

c.$25,800

d.$28,800



Gain on an involuntary conversion

(Pine has elected to replace the property within

the statutory period using total proceeds.)

Depreciation deducted for the tax purposes in

excess of depreciation deducted for book

purposes

Federal estimated tax payments, year 1

Enacted federal tax rates, year 1



$350,000

50,000



70,000

30%



What amount should Pine report as its current federal income

tax liability on its December 31, year 1 balance sheet?



4. Temporary differences arise when revenues are taxable

After they are

recognized in

financial income

Yes

Yes

No

No



30%



7. Pine Corp.’s books showed pretax income of $800,000 for

the year ended December 31, year 1. In the computation of

federal income taxes, the following data were considered:



As a result of these differences, future taxable amounts are











$16,000

20,000

10,000



If the alternative minimum tax provisions are ignored, what

amount of current federal income tax liability should be

reported in Dunn’s December 31, year 1 balance sheet?



Temporary differences amount to











c. Expenses or losses that are deductible before they are

recognized in financial income.

d. Revenues or gains that are recognized in financial

income but are never included in taxable income.



a. Expenses or losses that are deductible after they are

recognized in financial income.

b. Revenues or gains that are taxable before they are

recognized in financial income.













a.$50,000

b.$65,000

c.$120,000

d.$135,000



8. For the year ended December 31, year 1, Tyre Co. reported

pretax financial statement income of $750,000. Its taxable

income was $650,000. The difference is due to accelerated

depreciation for income tax purposes. Tyre’s effective income

tax rate is 30%, and Tyre made estimated tax payments during

year 1 of $90,000. What amount should Tyre report as current

income tax expense for year 1?











a.$105,000

b.$135,000

c.$195,000

d.$225,000



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9. Tower Corp. began operations on January 1, year 1. For

financial reporting, Tower recognizes revenues from all sales

under the accrual method. However, in its income tax returns,

Tower reports qualifying sales under the installment method.

Tower’s gross profit on these installment sales under each

method was as follows:

Year

Year 1

Year 2



Accrual method

$1,600,000

 2,600,000



Installment method

$ 600,000

1,400,000



The income tax rate is 30% for year 1 and future years.

There are no other temporary or permanent differences. In its

December 31, year 2 balance sheet, what amount should Tower

report as a liability for deferred income taxes?











a.$840,000

b.$660,000

c.$600,000

d.$360,000



10. On June 30, year 1, Ank Corp. prepaid a $19,000

premium on an annual insurance policy. The premium

payment was a tax deductible expense in Ank’s year 1 cash

basis tax return. The accrual basis income statement will report

a $9,500 insurance expense in year 1 and year 2.

Ank’s income tax rate is 30% in year 1 and 25% thereafter.

In Ank’s December 31, year 1 balance sheet, what amount

related to the insurance should be reported as a deferred

income tax liability?











a.$5,700

b.$4,750

c.$2,850

d.$2,375



Year

Year 1

Year 2

Year 3



Completedcontract

$—

400,000

700,000



10,000

(25,000)

$140,000



Zeff’s tax rate for year 1 is 40%.

12. In its year 1 income statement, what amount should Zeff

report as income tax expense—current portion?











a.$52,000

b.$56,000

c.$62,000

d.$64,000



13. In its December 31, year 1 balance sheet, what should

Zeff report as deferred income tax liability?











a.$2,000

b.$4,000

c.$6,000

d.$8,000



14. West Corp. leased a building and received the $36,000

annual rental payment on June 15, year 1. The beginning

of the lease was July 1, year 1. Rental income is taxable

when received. West’s tax rates are 30% for year 1 and

40% thereafter. West had no other permanent or temporary

differences. West determined that no valuation allowance was

needed. What amount of deferred tax asset should West report

in its December 31, year 1 balance sheet?

a.$5,400

b.$7,200

c.$10,800

d.$14,400



15. Black Co., organized on January 2, year 1, had pretax

accounting income of $500,000 and taxable income of

$800,000 for the year ended December 31, year 1. The only

temporary difference is accrued product warranty costs that are

expected to be paid as follows:



Percentage-ofcompletion

$300,000

 600,000

 850,000



Year 2

Year 3

Year 4

Year 5



$100,000

  50,000

  50,000

 100,000



The income tax rate was 30% for year 1 through year 3.

For years after year 3, the enacted tax rate is 25%. There

are no other temporary differences. Mill should report in its

December 31, year 3 balance sheet a deferred income tax

liability of



Black has never had any net operating losses (book or tax) and

does not expect any in the future. There were no temporary

differences in prior years. The enacted income tax rates are

35% for year 1, 30% for year 2 through year 4, and 25% for

year 5. In Black’s December 31, year 1 balance sheet, the

deferred income tax asset should be























a.$87,500

b.$105,000

c.$162,500

d.$195,000



Items 12 and 13 are based on the following:

Zeff Co. prepared the following reconciliation of its pretax

financial statement income to taxable income for the year

ended December 31, year 1, its first year of operations:

Pretax financial income

Nontaxable interest received on municipal

securities



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Long-term loss accrual in excess of deductible

amount

Depreciation in excess of financial statement

amount

Taxable income













11. Mill, which began operations on January 1, year 1,

recognizes income from long-term construction contracts

under the percentage-of-completion method in its financial

statements and under the completed-contract method for

income tax reporting. Income under each method follows:



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$160,000

(5,000)



a.$60,000

b.$70,000

c.$85,000

d.$105,000



16. A temporary difference that would result in a deferred tax

liability is











a. Interest revenue on municipal bonds.

b. Accrual of warranty expense.

c. Excess of tax depreciation over financial accounting

depreciation.

d. Subscriptions received in advance.



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17. Orleans Co., a cash-basis taxpayer, prepares accrual basis

financial statements. In its year 2 balance sheet, Orleans’

deferred income tax liabilities increased compared to year 1.

Which of the following changes would cause this increase in

deferred income tax liabilities?



Pretax income

Temporary differences:

Depreciation

Warranty costs

Taxable income

Enacted rate

Deferred tax accounts



I. An increase in prepaid insurance.

II. An increase in rent receivable.

III. An increase in warranty obligations.













a.

b.

c.

d.



Current

Noncurrent (before netting)



I only.

I and II.

II and III.

III only.



a.

b.

c.

d.











Liability

Yes

Yes

No

No



a. The current tax laws, regardless of expected or

enacted future tax laws.

b. Expected future tax laws, regardless of whether those

expected laws have been enacted.

c. Current tax laws, unless enacted future tax laws are

different.

d. Either current or expected future tax laws, regardless

of whether those expected laws have been enacted.



Interest on municipal bonds

Premium expense on keyman life insurance

Total



$70,000

(20,000)

$50,000



Grim’s enacted income tax rate is 30%. In its year 1 income

statement, what amount should Grim report as current

provision for income tax expense?

a.$45,000

b.$51,000

c.$60,000

d.$66,000



Items 21 and 22 are based on the following:

Venus Corp.’s worksheet for calculating current and deferred

income taxes for year 1 follows:



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(800) $(1,200) $2,000

400

(100)

(300)

$1,000

30%

30%

25%

Asset

$ (30)a

$ (75)b



Liability

$ 140c



 [($100) × 30%]

 [($300) × 25%]

c

 [($1,200) × 30%] + [$2,000 × 25%]



Venus had no prior deferred tax balances. In its year 1 income

statement, what amount should Venus report as

21. Current income tax expense?











a.$420

b.$350

c.$300

d.$0



22. Deferred income tax expense?











20. For the year ended December 31, year 1, Grim Co.’s

pretax financial statement income was $200,000 and its

taxable income was $150,000. The difference is due to the

following:













Year 3



b



19. A deferred tax liability is computed using





Year 2



a



18. At the end of year one, Cody Co. reported a profit on

a partially completed construction contract by applying the

percentage-of-completion method. By the end of year two,

the total estimated profit on the contract at completion in year

three had been drastically reduced from the amount estimated

at the end of year one. Consequently, in year two, a loss equal

to one-half of the year one profit was recognized. Cody used

the completed-contract method for income tax purposes and

had no other contracts. The year two balance sheet should

include a deferred tax

Asset

Yes

No

Yes

No



Year 1

$1,400



a.$350

b.$300

c.$120

d.$35



23. Shear, Inc. began operations in year 1. Included in Shear’s

year 1 financial statements were bad debt expenses of $1,400

and profit from an installment sale of $2,600. For tax purposes,

the bad debts will be deducted and the profit from the installment

sale will be recognized in year 2. The enacted tax rates are 30%

in year 1 and 25% in year 2. In its year 1 income statement, what

amount should Shear report as deferred income tax expense?











a.$300

b.$360

c.$650

d.$780



24. Quinn Co. reported a net deferred tax asset of $9,000 in its

December 31, year 1 balance sheet. For year 2, Quinn reported

pretax financial statement income of $300,000. Temporary

differences of $100,000 resulted in taxable income of $200,000

for year 2. At December 31, year 2, Quinn had cumulative

taxable differences of $70,000. Quinn’s effective income tax

rate is 30%. In its December 31, year 2, income statement, what

should Quinn report as deferred income tax expense?











a.$12,000

b.$21,000

c.$30,000

d.$60,000



25. Rein Inc. reported deferred tax assets and deferred tax

liabilities at the end of year 1 and at the end of year 2. For the

year ended 12/31/Y2, Rein should report deferred income tax

expense or benefit equal to the







a. Decrease in the deferred tax assets.

b. Increase in the deferred tax liabilities.



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Module 14: Deferred Taxes

c. Amount of the current tax liability plus the sum of

the net changes in deferred tax assets and deferred tax

liabilities.

d. Sum of the net changes in deferred tax assets and

deferred tax liabilities.



26. On its December 31, year 2 balance sheet, Shin Co. had

income taxes payable of $13,000 and a current deferred tax asset

of $20,000 before determining the need for a valuation account.

Shin had reported a current deferred tax asset of $15,000 at

December 31, year 1. No estimated tax payments were made

during year 2. At December 31, year 2, Shin determined that

it was more likely than not that 10% of the deferred tax asset

would not be realized. In its year 2 income statement, what

amount should Shin report as total income tax expense?











a.$8,000

b.$8,500

c.$10,000

d.$13,000



27. Under current generally accepted accounting principles,

which approach is used to determine income tax expense?











a.

b.

c.

d.



Asset and liability approach.

A “with and without” approach.

Net of tax approach.

Periodic expense approach.



D.  Deferred Tax Related to Business

Investments



Leer’s effective income tax rate was 30% in year 1. In

its year 1 income statement, Leer should report a current

provision for income taxes of











a.$26,400

b.$23,400

c.$21,900

d.$18,600



E.  Loss Carryforwards and Carrybacks

30. Dix, Inc., a calendar-year corporation, reported the

following operating income (loss) before income tax for its

first three years of operations:

Year 1

Year 2

Year 3



$100,000

(200,000)

400,000



There are no permanent or temporary differences between

operating income (loss) for financial and income tax reporting

purposes. When filing its year 2 tax return, Dix did not elect to

forego the carryback of its loss for year 2. Assume a 40% tax

rate for all years. What amount should Dix report as its income

tax liability at December 31, year 3?











a.$160,000

b.$120,000

c.$80,000

d.$60,000



In Bart’s December 31, year 1 balance sheet, the deferred

income tax liability should be



31. Town, a calendar-year corporation incorporated in

January year 1, experienced a $600,000 net operating loss

(NOL) in year 3 due to a prolonged strike. Town never had

a strike in the past that significantly affected its income and

does not expect such a strike in the future. Additionally,

there is no other negative evidence concerning future

operating income. For years 1–2, Town reported a taxable

income in each year, and a total of $450,000 for the two

years. Assume that: (1) there is no difference between

pretax accounting income and taxable income for all years,

(2) the income tax rate is 40% for all years, (3) the NOL

will be carried back to the profit years 1–2 to the extent of

$450,000, and $150,000 will be carried forward to future

periods. In its year 3 income statement, what amount should

Town report as the reduction of loss due to NOL carryback

and carryforward?























28. Bart, Inc., a newly organized corporation, uses the equity

method of accounting for its 30% investment in Rex Co.’s

common stock. During year 1, Rex paid dividends of $300,000

and reported earnings of $900,000. In addition













• The dividends received from Rex are eligible for the 80%

dividends received deductions.

• All the undistributed earnings of Rex will be distributed in

future years.

• There are no other temporary differences.

• Bart’s year 1 income tax rate is 30%.

• The enacted income tax rate after year 1 is 25%.



a.$10,800

b.$9,000

c.$5,400

d.$4,500



29. Leer Corp.’s pretax income in year 1 was $100,000.

The temporary differences between amounts reported in the

financial statements and the tax return are as follows:







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559



• Depreciation in the financial statements was $8,000 more

than tax depreciation.

• The equity method of accounting resulted in financial

statement income of $35,000. A $25,000 dividend was

received during the year, which is eligible for the 80%

dividends received deduction.



a.$240,000

b.$180,000

c.$270,000

d.$360,000



32. Bishop Corporation began operations in year 1 and

had operating losses of $200,000 in year 1 and $150,000

in year 2. For the year ended December 31, year 3, Bishop

had pretax book income of $300,000. For the three-year

period year 1 to year 3, assume an income tax rate of 40%

and no permanent or temporary differences between

book and taxable income. Because Bishop began operations

in year 1, the entire amount of deferred tax assets

recognized in year 1 and year 2 were offset with amounts

added to the allowance account. In Bishop’s year 3 income



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statement, how much should be reported as current income

tax expense?











a.$0

b.$40,000

c.$60,000

d.$120,000



33. Mobe Co. reported the following operating income (loss)

for its first three years of operations:

Year 1

Year 2

Year 3



$ 300,000

(700,000)

1,200,000



For each year, there were no deferred income taxes, and

Mobe’s effective income tax rate was 30%. In its year 2

income tax return, Mobe elected to carry back the maximum

amount of loss possible. Additionally, there was more negative

evidence than positive evidence concerning profitability for

Mobe in year 3. In its year 3 income statement, what amount

should Mobe report as total income tax expense?











a.$120,000

b.$150,000

c.$240,000

d.$360,000



F.  Financial Statement Presentation of

Income Tax

34. In year 1, Rand, Inc. reported for financial statement

purposes the following items, which were not included in

taxable income:

Installment gain to be collected

equally in year 2 through year 4

Estimated future warranty costs to be

paid equally in year 2 through year 4



Current

$60,000

$60,000

$50,000

$50,000



Noncurrent

$100,000

$120,000

$100,000

$120,000



Deferred tax

Related asset

assets (liabilities) classification

Accelerated tax depreciation

$(75,000)

Noncurrent

asset

Additional costs in inventory

25,000

Current asset

for tax purposes

$(50,000)



a.$40,000

b.$50,000

c.$65,000

d.$75,000



36. Because Jab Co. uses different methods to depreciate

equipment for financial statement and income tax purposes,

Jab has temporary differences that will reverse during the next

year and add to taxable income. Deferred income taxes that are

based on these temporary differences should be classified in

Jab’s balance sheet as a











a.

b.

c.

d.



Contra account to current assets.

Contra account to noncurrent assets.

Current liability.

Noncurrent liability.



37. At the most recent year-end, a company had a deferred

income tax liability arising from accelerated depreciation that

exceeded a deferred income tax asset relating to rent received

in advance which is expected to reverse in the next year.

Which of the following should be reported in the company’s

most recent year-end balance sheet?











2,100,000



35. Thorn Co. applies ASC Topic 740, Income Taxes. At the

end of year 1, the tax effects of temporary differences were as

follows:



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$1,500,000



There were no temporary differences in prior years. Rand’s

enacted tax rates are 30% for year 1 and 25% for year 2

through year 4.

In Rand’s December 31, year 1 balance sheet, what

amounts of the deferred tax asset should be classified as

current and noncurrent?

a.

b.

c.

d.



A valuation allowance was not considered necessary. Thorn

anticipates that $10,000 of the deferred tax liability will

reverse in year 2. In Thorn’s December 31, year 1 balance

sheet, what amount should Thorn report as noncurrent deferred

tax liability?



a. The excess of the deferred income tax liability over

the deferred income tax asset as a noncurrent liability.

b. The excess of the deferred income tax liability over

the deferred income tax asset as a current liability.

c. The deferred income tax liability as a noncurrent

liability.

d. The deferred income tax liability as a current liability.



38. On December 31, year 5, Oak Co. recognized a receivable

for taxes paid in prior years and refundable through the carryback

of all of its year 5 operating loss. Also, Oak had a year 5 deferred

tax liability derived from the temporary difference between tax

and financial statement depreciation, which reverses over the

period year 6–year 10. The amount of this tax liability is less

than the amount of the tax asset. Which of the following year 5

balance sheet sections should report tax-related items?

I. Current assets.

II. Current liabilities.

III. Noncurrent liabilities.













a.

b.

c.

d.



I only.

I and III.

I, II, and III.

II and III.



39. The amount of income tax applicable to transactions that

are not reported in the continuing operations section of the

income statement is computed







a. By multiplying the item by the effective income tax rate.

b. As the difference between the tax computed based on

taxable income without including the item and the tax

computed based on taxable income including the item.



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Module 14: Deferred Taxes

c. As the difference between the tax computed on the

item based on the amount used for financial reporting

and the amount used in computing taxable income.

d. By multiplying the item by the difference between

the effective income tax rate and the statutory income

tax rate.



40. No net deferred tax asset (i.e., deferred tax asset net

of related valuation allowance) was recognized in the year

1 financial statements by the Chaise Company when a loss

from discontinued operations was carried forward for tax

purposes because it was more likely than not that none of this

deferred tax asset would be realized. Chaise had no temporary

differences. The tax benefit of the loss carried forward reduced

current taxes payable on year 2 continuing operations. The

year 2 income statement would include the tax benefit from the

loss brought forward in











a.

b.

c.

d.



Income from continuing operations.

Gain or loss from discontinued operations.

Extraordinary gains.

Cumulative effect of accounting changes.



41. Which of the following statements is correct regarding the

provision for income taxes in the financial statements of a sole

proprietorship?













a. The provision for income taxes should be based on

business income using individual tax rates.

b. The provision for income taxes should be based on

business income using corporate tax rates.

c. The provision for income taxes should be based on

the proprietor’s total taxable income, allocated to the

proprietorship at the percentage that business income

bears to the proprietor’s total income.

d. No provision for income taxes is required.



I.  International Financial Reporting

Standards (IFRS)

42. Klaus corporation prepares its financial statements in

accordance with IFRS. Klaus locates its business in two

jurisdictions, France and Germany. Assume that in each

country Klaus has the legal right to offset the taxes receivable

and payable. Klaus prepares its taxes based on taxing authority



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561



and has the following information related to its deferred tax

assets and liabilities.

Classification

Deferred tax asset

Deferred tax liability

Deferred tax liability



Amount

$4,000

$2,500

$3,000



Taxing

jurisdiction

France

Germany

France



How should Klaus present its deferred taxes on its December

31, year 1 statement of financial position?



a.

b.

c.

d.



Deferred

tax asset

$4,000

$1,000

$0

$1,500



Deferred

tax liability

$5,500

$2,500

$1,500

$3,000



43. Which of the following is true regarding reporting

deferred taxes in financial statements prepared in accordance

with IFRS?











a. Deferred tax assets and liabilities are classified as

current and noncurrent based on their expiration dates.

b. Deferred tax assets and liabilities may only be

classified as noncurrent.

c. Deferred tax assets are always netted with deferred

tax liabilities to arrive at one amount presented on the

balance sheet.

d. Deferred taxes of one jurisdiction are offset against

another jurisdiction in the netting process.



44. Toller Corp. reports in accordance with IFRS. The

controller of the company is attempting to prepare the

presentation of deferred taxes on Toller’s financial statements.

Which of the following is correct about the presentation of

deferred tax assets and liabilities under IFRS?











a. Current deferred tax assets are netted against current

deferred tax liabilities.

b. All noncurrent deferred tax assets are netted against

noncurrent deferred tax liabilities.

c. Deferred tax assets are never netted against deferred

tax liabilities.

d. Deferred tax assets are netted against deferred tax

liabilities if they relate to the same taxing authority.



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Module 14: Deferred Taxes



562



Multiple-Choice Answers and Explanations

Answers

1.c

2.a

3.b

4.a

5.c

6.b

7.a

8.c

9.b

10. d



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11.c

12.b

13.c

14.b

15.c

16.c

17.b

18.b

19.c

20.a



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21.c

22.d

23.a

24.c

25.d

26.c

27.a

28.b

29.b

30.b



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31.a

32.a

33.c

34.c

35.d

36.d

37.c

38.b

39.b

40.a



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41.d

42.b

43.b

44.d



__ __

__ __

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__ __



1st: __/44 = __%

2nd: __/44 = __%



Explanations

1.(c) The objective of accounting for income taxes is to

recognize the amount of current and deferred taxes payable or

refundable at the date of the financial statements. The standard

further states that this objective is implemented through

recognition of deferred tax liabilities or assets. Deferred

tax expense results from changes in deferred tax assets and

liabilities.

2.(a) Temporary differences are differences between

taxable income and accounting income which originate in one

period and reverse in one or more subsequent periods. The

payment of a penalty ($5,000) and insurance premiums where

the corporation is the beneficiary ($10,000) are not temporary

differences because they never reverse. These are examples

of permanent differences, which are items that either enter

into accounting income but never into taxable income (such as

these two items), or enter into taxable income but never into

accounting income.

3. (b) The officer insurance policy difference ($75,000) is a

permanent difference which does not result in future taxable

or deductible amounts. The warranty difference ($50,000)

is a temporary difference, but it results in future deductible

amounts in future years when tax warranty expense exceeds

book warranty expense. However, the equipment difference

($80,000) is a temporary difference that results in future

taxable amounts in future years when tax depreciation is less

than book depreciation.

4.(a) Examples of temporary differences are revenues

which are taxable both before and after they are recognized

in financial income. Note that emphasis is placed on the

difference between book and tax, not the chronological order

of the reporting.

5. (c) Expenses or losses that are deductible before they

are recognized in financial income would result in future

taxable amounts. For example, the cost of an asset may have

been deducted for tax purposes faster than it was depreciated

for financial reporting. In future years, tax depreciation will

be less than financial accounting depreciation, meaning

future taxable income will exceed future financial accounting

income. Answers (a) and (b) are temporary differences that



c11.indd 562



would result in future deductible amounts. Answer (d) is

a permanent difference that does not result in either future

taxable or future deductible amounts.

6.(b) To determine the current federal tax liability, book

income ($90,000) must be adjusted for any temporary or

permanent differences to determine taxable income.

Book income

Rent received in advance

Municipal interest

Excess tax depreciation

Taxable income



$ 90,000

16,000

(20,000)

(10,000)

$ 76,000



Rent received in advance (temporary difference) is added to

book income because rent is taxable when received, but is not

recognized as book revenue until earned. Municipal interest

(permanent difference) is subtracted from book income

because it is excluded from taxable income. The excess tax

depreciation (temporary difference) is subtracted because

this excess amount is an additional tax deduction beyond

accounting depreciation. The current tax liability is computed

by multiplying taxable income by the tax rate ($76,000 × 30%

= $22,800).

7.(a)The current federal income tax liability is based

on taxable income, which is computed in the “book to tax

reconciliation” below.

Accounting income

Nontaxable gain

Excess tax depreciation

Taxable income



$ 800,000

(350,000)

(50,000)

$ 400,000



The gain on involuntary conversion was included in accounting

income but is deferred for tax purposes. Depreciation

deducted for tax purposes in excess of book depreciation also

causes taxable income to be less than accounting income.

Taxes payable before considering estimated tax payments is

$120,000 ($400,000 × 30%). Since tax payments of $70,000

have already been made, the 12/31/Y1 current federal income

tax liability is $50,000 ($120,000 – $70,000).



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Module 14: Deferred Taxes



8.(c) Income tax expense must be reported in two

components: the amount currently payable (current portion)

and the tax effects of temporary differences (deferred portion).

The current portion is computed by multiplying taxable

income by the current enacted tax rate ($650,000 × 30% =

$195,000). The deferred portion is $30,000 ($100,000

temporary difference × 30%). The estimated tax payments

($90,000) do not affect the amount of tax expense, although

the payments would decrease taxes payable.

9.(b) Over the two years, accounting income on the accrual

basis is $4,200,000 ($1,600,000 + $2,600,000) and taxable

income using the installment method is $2,000,000 ($600,000

+ $1,400,000). This results in future taxable amounts at 12/31/

Y2 of $2,200,000 ($4,200,000 – $2,000,000). Therefore,

at 12/31/Y2, Tower should report a deferred tax liability of

$660,000 ($2,200,000 × 30%).

10.(d) For accounting purposes, prepaid insurance is $9,500

at 12/31/Y1. For tax purposes, there was no prepaid insurance

at 12/31/Y1, since the entire amount was deducted on the year

1 tax return. Therefore, the temporary difference is $9,500.

This temporary difference will result in a future taxable

amount in year 2, when the tax rate is 25%. Therefore, at

12/31/Y1, a deferred tax liability of $2,375 (25% × $9,500)

must be reported.

11.(c) Mill’s total accounting income using percentage-ofcompletion ($300,000 + $600,000 + $850,000 = $1,750,000)

will eventually be subject to federal income taxes. However,

by 12/31/Y3, only $1,100,000 of income ($400,000 +

$700,000) has been reported as taxable income using the

completed-contract method. The amount of accounting income

which has not yet been taxed ($1,750,000 – $1,100,000 =

$650,000 temporary difference) will be taxed eventually

when the related contracts are completed. The resulting future

taxable amounts will all be taxed after year 3 when the enacted

tax rate is 25%. Therefore, the 12/31/Y3 deferred tax liability

is $162,500 ($650,000 × 25%). To record the liability, the

following entries would be made each year:

Year 1

Income tax expense—deferred

Deferred tax liability



90,000

90,000



Year 2

Income tax expense—deferred

Deferred tax liability



60,000



13.(c) The deferred tax liability reported at 12/31/Y1

results from future taxable (and possibly deductible) amounts

which exist as a result of past transactions, multiplied by

the appropriate tax rate. The nontaxable interest received

on municipal securities ($5,000) is a permanent difference

that does not result in future taxable or deductible amounts.

The Codification requires the netting of current deferred tax

assets and liabilities, and noncurrent deferred tax assets and

liabilities. The future deductible amount ($10,000) resulting

from a loss accrual results in a long-term deferred tax asset of

$4,000 ($10,000 × 40%) because it is related to a long-term

loss accrual. The future taxable amount ($25,000) caused

by depreciation results in a long-term deferred tax liability

of $10,000 ($25,000 × 40%) because it is related to a longterm asset (property, plant, and equipment). Since these are

both long-term, they are netted and a long-term deferred tax

liability of $6,000 is reported in the balance sheet ($10,000

liability less $4,000 asset).

14.(b) At 12/31/Y1, unearned rent for financial accounting

purposes is $18,000 ($36,000 × 6/12). The amount of rent

revenue recognized on the income statement is six of twelve

months (36,000 × 6/12) = 18,000. Rental income on the

tax return is $36,000 because rental income is taxed when

received. Therefore, the timing difference is $18,000 ($36,000

– $18,000 = $18,000) giving rise to a deferred tax asset on the

balance sheet of $18,000 × 40% = $7,200. The deferred tax

asset to be recorded is measured using the future enacted tax

rate of 40%.

15.(c) A deferred tax asset is recognized for all deductible

temporary differences. The computation of the deferred tax

asset for Black Co. arising from the accrued product warranty

costs of $300,000 is shown below.

Year 2

Future

$100,000

deductible

amounts

30%

Tax rate

Deferred tax $ 30,000

asset



Year 3

Year 4

Year 5

Total

$50,000 $50,000 $100,000 $300,000



30%

30%

$15,000 $15,000



25%

$ 25,000 $ 85,000



Thus, the total deferred tax asset at the end of year 1 is $85,000.



12,500



16.(c) An excess of tax depreciation over financial

accounting depreciation results in future taxable amounts and,

therefore, a deferred tax liability. Answer (a) is an example of

a permanent difference that does not result in future taxable

or deductible amounts. Answers (b) and (d) are examples of

temporary differences that result in future deductible amounts

and a possible deferred tax asset.



12,500



The total in the deferred tax liability account on 12/31/Y3

should be $162,500. Therefore, the entry in year 3 is the

amount needed to correctly state the deferred tax liability

account. Since $150,000 was already accrued in the deferred

tax liability account in year 1 and year 2, the entry for year 3 is

$162,500 – $150,000, or $12,500.

12.(b) Income tax expense must be reported in two

components: the amount currently payable (current portion)

and the tax effects of temporary differences (deferred portion).



c11.indd 563



The amount currently payable, or current income tax expense,

is computed by multiplying taxable income by the current

enacted tax rate ($140,000 × 40% = $56,000).



60,000



Year 3

Income tax expense—deferred

Deferred tax liability



563



17.(b) The increase in prepaid insurance in year 2 creates a

deductible amount for income tax reporting purposes for the

insurance paid; however, for financial reporting purposes the

expense is not recognized until years subsequent to year 2. As

a result, net taxable income for future years is increased, thus,

the deferred income tax liability increases. The increase in rent



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Module 14: Deferred Taxes



receivable in year 2 also increases the deferred tax liability.

For income tax purposes, rents are not included in income

until received (i.e., years subsequent to year 2). However,

the amount of the receivable is earned and recognized in

the income statement in year 2. The increase in warranty

obligations results in warranty expense for year 2 and will

provide future deductible amounts, because under the IRC, a

deduction for warranty cost is not permitted until such cost

is incurred. Future deductible amounts lead to deferred tax

assets.

18.(b) A deferred tax liability is recognized for temporary

differences that will result in net taxable amounts (taxable

income exceeds book income) in future years. Although

Cody Co. has recognized a loss (per books) in year two of

the construction contract, the contract is still profitable over

the three years. Therefore, in year three when the contract

is completed, Cody will recognize the total profit on its tax

return, and only a portion of the profit will be recorded in its

income statement. Thus, the contract will result in a taxable

amount in year three and a deferred tax liability exists. Note

that this liability was recorded at the end of year 1 and reduced

by one-half at the end of year two due to the change in

estimated profit. Answers (a) and (c) are incorrect because no

deferred tax asset is created. Answer (d) is incorrect because

Cody will include a deferred tax liability on its balance sheet.

19.(c) A deferred tax liability is recognized for the amount

of taxes payable in future years as a result of the deferred tax

consequences (as measured by the provisions of enacted tax

laws) of events recognized in the financial statements in the

current or preceding years.

20.(a) Income tax provision (expense) must be reported

in two components: the amount currently payable (current

portion) and the tax effects of temporary differences (deferred

portion). The current portion is computed by multiplying

taxable income by the current enacted tax rate ($150,000 ×

30% = $45,000). Note that in this case, the deferred portion is

$0, because both differences are permanent differences, which

do not result in a deferred tax liability. Therefore, the current

provision for income taxes should be reported at $45,000. It

is important to note that if temporary differences did exist the

tax effects would have been included in the tax expense for the

current period.

21.(c) Income tax expense must be reported in two

components: the amount currently payable (current portion)

and the tax effects of temporary differences (deferred portion).

The amount currently payable, or current income tax expense,

is computed by multiplying taxable income by the current

enacted tax rate ($1,000 × 30% = $300).

22.(d) Income tax expense must be reported on the IS in two

components: the amount currently payable (current portion)

and the tax effects of temporary differences (deferred portion).

Note that scheduling is required in this question because the

tax rates are not the same in all future years. The worksheet

indicates two temporary differences: depreciation and warranty

costs. The scheduling contained in the worksheet shows that

these two temporary differences will result in a deferred tax

asset of $105 ($30 + $75) and deferred tax liability of $140.

The liability has the effect of increasing year 1 tax expense



c11.indd 564



while the asset has the effect of decreasing year 1 tax expense.

The net effect is deferred income tax expense of $35 for year 1

[$140 – ($30 + $75)].

Not required:

The balance sheet presentation would show a current deferred

tax asset of $30 and a noncurrent deferred tax liability of $65

($140 – $75).

23.(a) The deferred portion of income tax expense can be

computed by determining the tax effect of the two temporary

differences. The installment sale profit results in a future taxable

amount in year 2 of $2,600, and the bad debt expense results

in a future deductible amount of $1,400. The deferred tax

consequences of these temporary differences will be measured

by Shear in year 1 using the enacted tax rate expected to apply

to taxable income in the year the deferred amounts are

expected to be settled. The following journal entry is necessary

to record the deferred tax liability related to the installment sale:

Deferred tax expense

Deferred tax liability

[$2,600 × .25]



650

650



To record the deferred tax asset related to the bad debt

expense, the following journal entry is required:

Deferred tax asset

Deferred tax expense

[$1,400 × .25]



350

350



The amount of deferred tax expense to be reported by Shear

in its year 1 income statement is $300 ($650 - $350). Note

that one journal entry could have been used. Using two entries

more clearly shows the opposite effect of an asset versus a

liability on deferred tax expense.

24.(c) Income tax expense must be reported in two

components: the amount currently payable (current portion)

and the tax effects of temporary differences (deferred

portion). The current portion is computed by multiplying

taxable income by the current enacted tax rate ($200,000 ×

30% = $60,000). The deferred portion is $30,000 ($100,000

temporary difference × 30%). An alternative computation for

the deferred portion is shown below.

DT asset at 12/31/Y2

DT asset at 12/31/Y1

Decrease in DT asset

DT liability at 12/31/Y2

($70,000 × 30%)

DT liability at 12/31/Y1

Increase in DT liability

Deferred portion of tax expense



$



0

9,000

$ 9,000



$21,000

0

21,000

$30,000



25.(d) The deferred income tax expense or benefit is the

net change during the year in an enterprise’s deferred tax

liabilities or assets. The deferred income tax expense or

benefit must consider the net effect of changes (both increases

and decreases) in both deferred tax assets and deferred tax

liabilities. The decrease in deferred tax assets alone or the

increase in deferred tax liabilities alone will not be equal to



13-05-2014 07:38:36



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