Kingpin804

Which of the following financial ratios is least likely to be affected by classification of deferred taxes as a liability or equity?

A) Return on assets (ROA).

B) Return on equity (ROE).

C) Debt-to-total assets.

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The ROA will not be affected by the classification of the deferred taxes. The total assets will remain the same regardless of whether the deferred taxes are classified as a liability or equity.

Kingpin804

Which of the following factors will NOT impact the classification of deferred tax liabilities?

A) Present value of the future payments.

B) Growth of the firm.

C) Changes in firm operations.

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The present value of the future payments will not impact the classification of deferred tax liabilities. Growth of the firm and the firm’s operations can each have an impact on classification of deferred tax liabilities. These can result in non-payment of deferred taxes even if they are reversed.

Kingpin804

For purposes of financial analysis, an analyst should:

A) determine the treatment of deferred tax liabilities on a case-by-case basis.

B) always consider deferred tax liabilities as stockholder's equity.

C) always consider deferred tax liabilities as a liability.

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For financial analysis, an analyst must decide on the appropriate treatment of deferred taxes on a case-by-case basis. These can be classified as liabilities or stockholder’s equity, depending on various factors. Sometimes, deferred taxes are just ignored altogether.

Kingpin804

At the end of 20X8, Martin Inc. estimates that $26,000 of warranty repairs will be required in the future on goods already sold. For tax purposes, warranty expense is not deductible until the work is actually performed. The firm believes that the warranty work will be required over the next two years. The tax base of the warranty liability at the end of 20X8 is:

A) zero.

B) $13,000.

C) $26,000.

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The carrying value of the warranty liability is $26,000 (the same amount is recorded as a liability on the balance sheet and as an expense on the income statement). The tax base is equal to the carrying value less any amounts deductible in the future. Therefore, the tax base is $0 ($26,000 − $26,000) since the warranty expense will be deductible when the work is performed next year.

Kingpin804

In 20X8, Oliver Ltd. received $80,000 cash from a customer for goods that it could not deliver until the next year and established a liability for unearned revenue. Oliver reports under U.S. GAAP, faces a 40% tax rate, and is located in a tax jurisdiction where unearned revenue is taxed as received. On their balance sheet for 20X8, what change in deferred tax should Oliver record as a result of this transaction?

A) A deferred tax asset of $32,000.

B) A deferred tax liability of $32,000.

C) There is no effect on deferred tax items from this transaction.

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Oliver has paid tax on the $80,000 revenue in 20X8, but has not recorded the revenue on it for financial statement purposes. This results in a temporary difference of $32,000, which is a deferred tax asset. The tax asset will be realized when the company recognizes the revenue on its financial statements in the subsequent period.

Kingpin804

Alter Inc. determines that it has $35,000 of accounts receivable outstanding at the end of 20X8. Based on past experience, it recognizes an allowance for bad debt equal to 10% of its credit sales. The tax base of Alter’s accounts receivable at the end of 20X8 is closest to:

A) $31,500.

B) $3,500.

C) $35,000.

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For tax purposes, bad debt expense cannot be deducted until the receivables are deemed worthless. Therefore, the tax base is $35,000 since no bad debt expense has been deducted on the tax return. Note that the carrying value would be $31,500 since bad debt expense is reflected on the income statement.

Kingpin804

A firm buys an asset with an estimated useful life of five years for $100,000 at the beginning of the year. The firm will depreciate the asset on a straight-line basis with no salvage value on its financial statements and will use double declining balance depreciation for tax. The tax basis for this asset at the end of the first year is closest to:

A) $60,000.

B) $80,000.

C) $40,000.

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For tax, the asset’s basis is reduced by the DDB depreciation (2/5 × 100,000 = 40,000) from $100,000 to $60,000.

Kingpin804

Nespa, Inc., has a deferred tax liability on its balance sheet in the amount of $25 million. A change in tax laws has increased future tax rates for Nespa. The impact of this increase in tax rate will be:

A) a decrease in deferred tax liability and a decrease in tax expense.

B) an increase in deferred tax liability and an increase in tax expense.

C) a decrease in deferred tax liability and an increase in tax expense.

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An increase in tax rates will increase future deferred tax liability, and the impact of the increase in liability will be reflected in the income statement of the year in which the tax rate change is effected.

Kingpin804

On its financial statements for the year ended December 31, Jackson, Inc. listed $2,000,000 in post retirement benefits expense. Jackson, Inc. contributed $200,000 of the expense to its retirement plan during the year. Tax law recognizes cash contributions to a pension account as tax deductible, but not expense accruals. Jackson’s tax rate is 40%.
For the year ended December 31, Jackson, Inc. should show, based on the above, an increase in its deferred tax:

A) asset account of $720,000.

B) liability account of $720,000.

C) liability account of $80,000.

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Jackson’s post-retirement benefits expense will decrease income tax expense by $2,000,000 × 0.40 = $800,000. The cash contribution will decrease income taxes payable by $200,000 × 0.40 = $80,000. Because taxes payable will exceed income tax expense, the difference of $800,000 − $80,000 = $720,000 is an increase in the deferred tax asset account.

Kingpin804

Corcoran Corp acquired an asset on 1 January 2004, for $500,000. For financial reporting, Corcoran will depreciate the asset using the straight-line method over a 10-year period with no salvage value. For tax purposes the asset will be depreciated straight line for five years and Corcoran’s effective tax rate is 30%. Corcoran’s deferred tax liability for 2004 will:

A) decrease by $50,000.

B) decrease by $15,000.

C) increase by $15,000.

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Straight-line depreciation per financial reports = 500,000 / 10 = $50,000
Tax depreciation = 500,000 / 5 = $100,000
Temporary difference = 100,000 − 50,000 = $50,000
Deferred tax liability will increase by $50,000 × 30% = $15,000