deferred tax question its, following, question, practice

simeezee

hi there, the following question is from the schweser practice exams book #1, exam3, AM session.

A has sold a luxury oassenger boat from its inventory on dec-31 for $2m. it is estimated that A will incur $0.1m in warranty expenses over the 5y warranty period. A's tax rate is 35%. to account for tax implications of the warranty obligation prior to incurring warranty expenses, A should:

a. record DTA $30,000
b. record DTL $30,000
c. make no entry until actual warranty expenses are incurred

=> correct answer is a.

actually i think the DTL should be lower.
the tax base is zero.
the CV of the warranty liability for reporting purposes should accrue over the life of warranty period, right? that means in t=1 CV_rep is $100,000/5=$20,000.

thus in the first year the difference of the tax base/CV of the warranty liability is 20,000, multiplied by the tax rate of 30%, this yields a DTL of $6,000.

please help me out

bluejazzy

If the tax rate is 30%, then yes the answer is DTA of 30,000.

You would recognize the entire warranty expense. That is consistent with accrual basis accounting, record warranty expense at the time of sale.

JGovender

you're right... according to the matching principle the associated expenses have to follow the revenues for which they have been incurred.. realisation already completed, so, fully deduct warranty expense...
thanks