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

Kingpin804

A company purchased a new pizza oven directly from Italy for $12,676. It will work for 5 years and has no salvage value. The tax rate is 41%, and annual revenues are constant at $7,192. For financial reporting, the straight-line depreciation method is used, but for tax purposes depreciation is accelerated to 35% in years 1 and 2, and 30% in year 3. For purposes of this exercise ignore all expenses other than depreciation.What is the net income and depreciation expense for year one for financial reporting purposes?

Net Income

Depreciation Expense

A) $2,748 $2,535

B) $2,535 $3,169

C) $4,657 $2,748

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Net income in year 1 for financial reporting purposes will be $2,748 = [($7,192 − $2,535)(1 − 0.41)]
The annual depreciation expense on financial statements will be $2,535 = ($12,676 / 5 years)

Kingpin804

Kruger Associates uses an accrual basis for financial reporting purposes and cash basis for tax purposes. Cash collections from customers are $476,000, and accrued revenue is only $376,000. Assume expenses at 50% in both cases (i.e., $238,000 on cash basis and $188,000 on accrual basis), and a tax rate of 34%. What is the deferred tax asset or liability? A deferred tax:

A) asset of $48,960.

B) liability of $17,000.

C) asset of $17,000.

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Since taxable income ($238,000) exceeds pretax income ($188,000), Kruger will have a deferred tax asset of $17,000 [($238,000 − $188,000)(0.34)].

Kingpin804

Unit Technologies uses accrual basis for financial reporting purposes and cash accounting for tax purposes. So far this year, Unit Technologies has recorded $195,000 in revenue for financial reporting purposes, but, on a cash basis, revenue was only $131,000. Assume expenses at 50 percent in both cases (i.e., $ 97,500 on accrual basis and $ 65,500 on cash basis), and a tax rate of 34%. What is the deferred tax liability or asset? A deferred tax:

A) liability of $16,320.

B) liability of $10,880.

C) asset of $10,880.

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Since pretax income ($97,500) exceeds the taxable income ($65,500), United Technologies will have a deferred tax liability of $10,880 = [( $97,500 − $65,500)(0.34)]

Kingpin804

This year, Blue Horizon has recorded $390,000 in revenue for financial reporting purposes, but, on a cash basis, revenue was only $262,000. Assume expenses at 50% in both cases (i.e., $195,000 on accrual basis and $131,000 on cash basis), and a tax rate of 34%. What is the deferred tax liability or asset? A deferred tax:

A) liability of $21,760.

B) liability of $16,320.

C) asset of $21,760.

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Since pretax income ($195,000) exceeds the taxable income ($131,000), Blue Horizon will have a deferred tax liability of $21,760 [($195,000 − $131,000)(0.34)].

Kingpin804

Camphor Associates uses accrual basis for financial reporting purposes and cash basis for tax purposes. Cash collections from customers is $238,000, and accrued revenue is only $188,000. Assume expenses at 50% in both cases (i.e., $119,000 on cash basis and $94,000 on accrual basis), and a tax rate of 34%. What is the deferred tax asset/liability in this case? A deferred tax:

A) asset of $48,960.

B) liability of $8,500.

C) asset of $8,500.

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Since taxable income ($119,000) exceeds pretax income ($94,000), Camphor will have a deferred tax asset of $8,500 = [($119,000 − $94,000)(0.34)].

Kingpin804

A firm purchased a piece of equipment for $6,000 with the following information provided:

• Revenue will increase by $15,000 per year.
• The equipment has a 3-year life expectancy and no salvage value.
• The firm's tax rate is 30%.
• Straight-line depreciation is used for financial reporting and double declining balance is used for tax purposes.

Calculate the incremental income tax expense for financial reporting for years 1 and 2.

Year 1

Year 2

A) $3,300 $4,100

B) $3,900 $3,900

C) $600 -$200

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Using SL:

	Yr. 1	Yr. 2
Revenue	15,000	15,000
Dep.	2,000	2,000
Pretax income	13,000	13,000
Tax Expense	3,900	3,900

Kingpin804

Laser Tech has net temporary differences between tax and book income resulting in a deferred tax liability of $30.6 million. According to U.S. GAAP, an increase in the tax rate would have what impact on deferred taxes and net income, respectively:

Deferred Taxes

Net Income

A) Increase Decrease

B) Increase No effect

C) No effect Decrease

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If tax rates rise then deferred tax liabilities will also rise.  The increase in deferred tax liabilities will increase the current tax expense, and if expenses are increasing the net income will decrease.

Kingpin804

A dance club purchased new sound equipment for $25,352. It will work for 5 years and has no salvage value. Their tax rate is 41%, and their annual revenues are constant at $14,384. For financial reporting, the straight-line depreciation method is used, but for tax purposes depreciation is accelerated to 35% in years 1 and 2 and 30% in Year 3. For purposes of this exercise ignore all expenses other than depreciation.Assume that the tax rate changes for years 4 and 5 from 41% to 31%. What will be the deferred tax liability as of the end of year three?

A) $1,039.

B) $2,948.

C) $3,144.

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Straight-line depreciation = $25,352 / 5 = $5,070. Income using straight-line depreciation = $14,384 − $5,070 = $9,314. Accelerated depreciation (years 1 and 2) = 0.35($25,352) = $8,873. Income (years 1 and 2) = $14,384 − $8,873 = $5,511. Accelerated depreciation (year 3) = 0.3($25,352) = $7,606. Income (year 3) = $14,384 − $7,606 = $6,778. Deferred tax liability at the end of year three, after the change in the expected tax rate, will be $3,144:
DTL for year 1 = $1,178.93 = [($9,314 − $5,511)(0.31)].
DTL for year 2 = $1,178.93 = [($9,314 − $5,511)(0.31)].
DTL for year 3 = $786.16 = [($9,314 − $6,778)(0.31)]
$1,178.93 + $1,178.93 + $786.16 = $3,144

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Because the tax rate changes for years 4 and 5 from 41% to 31%, net income will have to be adjusted for financial reporting purposes in year three. What is the amount of this adjustment?

A) $1,030.

B) $747.

C) $1,014.

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The deferred tax liability will decrease by $1,014 = ($4,158 − $3,144) due to the new lower tax rate. An adjustment of $1,014 in tax expense will result in an increase in net income by the same amount of $1,014.
Deferred tax liability at the end of year 3 with tax rate of 41% = $4,158.
Deferred tax liability at the end of year 3 with tax rate of 31% = $3,144.

Kingpin804

An analyst gathered the following data for Alice Company.

• 
  Alice Company reported a pretax income of $400,000 in its income statement for the period ended December 31, 2002.
• 
  Included in its pretax income are: (1) interest received on tax-free municipal bonds $50,000 and (2) rent expense of $20,000. (Only $10,000 was paid in cash for rent during 2002).
• 
  Alice follows cash basis for tax reporting.
• 
  Assume a tax rate of 40%.

What is the income tax expense that Alice should report on its income statement for the year ended December 31, 2002?

A) $160,000.

B) $140,000.

C) $132,000.

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$400,000 – 50,000 = $350,000. $350,000 × 40% = $140,000

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Based on the information provided, which of the following is most accurate with respect to deferred tax during 2002? Deferred tax:

A) liability will increase by $4,000.

B) will remain unchanged.

C) asset will increase by $4,000.

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Since only $10,000 of the rent expense will be allowed per tax returns, a deferred tax asset of $4,000 will result ($10,000 × 40%).

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All else equal, when a company issues bonds at a premium, the debt/equity ratio will show:

A) an increasing trend over the life of the bond.

B) a decreasing trend over the life of the bond.

C) stable trend over the life of the bond.

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Net book value of debt decreases from amortization of the premium, while stockholders’ equity increases (due to increasing earnings). This decreases debt/equity ratio over the life of the bond.