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Chapter 14

True/False

Indicate whether the statement is true or false.

____ 1. If a corporation has no subsidiaries outside the U.S., its book and taxable income are identical.

____ 2. Only U.S. corporations are included in a combined GAAP financial statement.

____ 3. Domestic and foreign entities owned more than 80% are included in a consolidated group’s U.S. tax return.

____ 4. Giant uses the “equity method” to account for the operations of its 40% owned subsidiary Little. A portion of

Little’s profits for the year are included in Giant’s GAAP book income.

____ 5. The operations of an 80% or more owned domestic subsidiaries must be included in the parent corporation’s

consolidated tax return.

____ 6. Yahr, Inc., is a domestic corporation with no subsidiaries. It operates in almost every U.S. state. Yahr records

no permanent or temporary book-tax differences this year. Yahr’s tax expense on its GAAP financial

statements and its tax liability reported on its Federal income tax return are identical.

____ 7. “Temporary differences” are book-tax income differences that eventually appear in both the financial

statements and the income tax return, but not in the same reporting period.

____ 8. Schedule M-3 of the tax return Form 1120 reconciles financial statement net income after tax with a large

corporation’s taxable income.

____ 9. “Permanent differences” include items that appear in the Federal income tax return as income or deduction,

and in the GAAP financial statements as revenue or expense, but in different reporting periods.

____ 10. In general, the purpose of ASC 740 (SFAS 109) is to compute and disclose the actual taxes paid by a business

entity to state, local, Federal, and foreign governments for the current year.

____ 11. The current tax expense reported on the GAAP financial statement generally represents the taxes actually

payable to domestic or foreign governmental authorities.

____ 12. A deferred tax liability represents a potential future tax benefit associated with income reported in the current

year GAAP financial statements.

____ 13. A deferred tax liability represents a current tax liability associated with income or expense to be reported in

future year GAAP financial statements.

____ 14. A deferred tax asset is the expected future tax benefit (savings) associated with income reported in the current

year GAAP financial statements.

____ 15. A deferred tax asset is the current tax benefit (savings) associated with income or expense to be reported in

future year GAAP financial statements.

____ 16. The valuation allowance can reduce either a deferred tax asset or a deferred tax liability.

____ 17. If a valuation allowance is increased in the current year, the corporation’s effective tax rate is higher than if

the valuation allowance had not increased.

____ 18. If a valuation allowance is decreased (released) in the current year, the corporation’s effective tax rate is

higher than if the valuation allowance had not increased.

____ 19. Under GAAP, a corporation can defer a disclosure of the future U.S. tax expense related to the earnings of

foreign subsidiaries, by taking into account its repatriation plans for these earnings.

____ 20. One can describe the benefits of ASC 740-30 (APB 23) as “all or nothing.” If it is elected, APB 23 applies to

the earnings from all foreign subsidiaries, in the current year and thereafter.

____ 21. Repatriating prior year earnings from a foreign subsidiary located in a low-tax country where ASC 740-30

(APB 23) benefits were previously adopted will cause an increase in a corporation’s current year effective tax

rate.

____ 22. The taxpayer should use the technique of ASC 740-30 (APB 23) income deferral only when the tax rates that

apply to the subsidiary are less than those of the applicable U.S. income tax rate.

____ 23. The income tax note to the GAAP financial statements includes a reconciliation of a corporation’s

hypothetical tax on book income to its book tax expense as if it were taxed at the applicable U.S. income tax

rates.

____ 24. In the “rate reconciliation” of GAAP tax footnotes, temporary book-tax differences are reconciled between

book income as if taxed at U.S. tax rates and the actual book income tax expense.

____ 25. A $50,000 cash tax savings that is temporary has the same effect on a corporation’s current year effective tax

rate as a $50,000 cash tax savings that is a permanent difference.

____ 26. ASC 740 (FIN 48) allows companies to choose their own level of certainty in reporting uncertain tax

positions in their financial statements.

____ 27. ASC 740 (FIN 48) replaced FAS 5, Accounting for Contingencies, with regard to accounting for uncertain tax

positions.

____ 28. The major purpose of ASC 740 (SFAS 109) is to build a cushion into currently reported income tax expense

in order to insure that the financial statements are conservative.

____ 29. Current tax expense always totals the amount a taxpayer actually paid all Federal, state, and foreign tax

authorities in a particular year.

Multiple Choice

Identify the choice that best completes the statement or answers the question.

____ 1. Purple, Inc., a domestic corporation, owns 100% of Blue, Ltd., a foreign corporation and Yellow, Inc., a

domestic corporation. Purple also owns 40% of Green, Inc., a domestic corporation. Purple receives no

distributions from any of these corporations. Which of these entities’ net income are included in Purple’s

GAAP income statement for current year financial reporting purposes?

a. Purple, Blue, Yellow, and Green. b. Purple, Blue, and Yellow. c. Purple, Blue, and Green. d. Purple, Yellow, and Green.

____ 2. Create, Inc., a domestic corporation, owns 100% of Vinyl, Ltd., a foreign corporation and Digital, Inc., a

domestic corporation. Create also owns 12% of Record, Inc., a domestic corporation. Create receives no

distributions from any of these corporations. Which of these entities’ net income are included in Create’s

income statement for current year financial reporting purposes?

a. Create, Vinyl, Digital, and Record. b. Create, Vinyl, and Record. c. Create, Vinyl, and Digital. d. Create, Digital, and Record. e. None of the above.

____ 3. Purple, Inc., a domestic corporation, owns 80% of Blue, Ltd., a foreign corporation and Yellow, Inc., a

domestic corporation. Purple also owns 50% of Green, Inc., a domestic corporation. Purple receives no

distributions from any of these corporations. Which of these entities’ net income are included in Purple’s

Federal tax return for the current year assuming Purple elects to include all eligible entities in its consolidated

Federal income tax return?

a. Purple, Blue, Yellow, and Green. b. Purple, Blue, and Yellow. c. Purple, Blue, and Green. d. Purple and Yellow.

____ 4. Create, Inc., a domestic corporation, owns 90% of Vinyl, Ltd., a foreign corporation and Digital, Inc., a

domestic corporation. Create also owns 60% of Record, Inc., a domestic corporation. Create receives no

distributions from any of these corporations. Which of these entities’ net income are included in Create’s

Federal tax return for the current year assuming Create elects to include all eligible entities in its consolidated

Federal income tax return?

a. Create and Digital. b. Create, Vinyl, and Digital. c. Create, Vinyl, and Record. d. Create, Vinyl, Digital, and Record.

____ 5. Which of the following taxes are included in the total income tax expense of a corporation as reported on its

financial statements?

a. State income taxes. b. Local income taxes. c. Foreign income taxes. d. Federal income taxes. e. All the above taxes are included.

____ 6. Which of the following taxes are included in the total income tax expense of a corporation reported on its

Federal tax return?

a. State income taxes. b. Local income taxes. c. Foreign income taxes. d. Federal income taxes. e. All the above taxes are included

____ 7. Which of the following items represents a temporary book-tax difference?

a. Municipal bond interest. b. Compensation-related expenses. c. Meals and entertainment expense deduction. d. Nondeductible penalties.

____ 8. Phyllis, Inc., earns book net income before tax of $600,000. Phyllis puts into service a depreciable asset this

year, and first year tax depreciation exceeds book depreciation by $120,000. Phyllis has recorded no other

temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35%, what is Phyllis’s total

income tax expense reported on its GAAP financial statements?

a. $252,000. b. $210,000. c. $168,000. d. $42,000.

____ 9. Gravel, Inc., earns book net income before tax of $600,000. Gravel puts into service a depreciable asset this

year, and first year tax depreciation exceeds book depreciation by $120,000. Gravel has recorded no other

temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35%, what is Gravel’s

current income tax expense reported on its GAAP financial statements?

a. $252,000. b. $210,000. c. $168,000. d. $42,000.

____ 10. Clipp, Inc., earns book net income before tax of $600,000. Clipp puts into service a depreciable asset this

year, and first year tax depreciation exceeds book depreciation by $120,000. Clipp has recorded no other

temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35%, what is Clipp’s

deferred income tax liability reported on its GAAP financial statements?

a. $252,000. b. $210,000. c. $168,000. d. $42,000.

____ 11. Jogg, Inc., earns book net income before tax of $600,000. Jogg puts into service a depreciable asset this year,

and first year tax depreciation exceeds book depreciation by $120,000. Jogg has recorded no other temporary

or permanent book-tax differences. Assuming that the U.S. tax rate is 35%, and that this is Jogg’s first year of

operations, what is Jogg’s balance in its deferred tax asset and deferred tax liability accounts at year end?

a. $42,000 and $0. b. $0 and $42,000. c. $42,000 and $42,000. d. $0 and $0.

____ 12. Qute, Inc., earns book net income before tax of $500,000. In computing its book income, Qute deducts

$50,000 more in warranty expense for book purposes than is allowed for tax purposes. Qute records no other

temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35% and no valuation

allowance is required, what is Qute’s total income tax expense reported on its GAAP financial statements?

a. $192,500. b. $175,000. c. $157,500. d. $17,500.

____ 13. Morrisson, Inc., earns book net income before tax of $500,000. In computing its book income, Morrisson

deducts $50,000 more in warranty expense for book purposes than is allowed for tax purposes. Morrisson

records no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35% and no

valuation allowance is required, what is Morrisson’s current income tax expense reported on its GAAP

financial statements?

a. $192,500. b. $175,000. c. $157,500. d. $17,500.

____ 14. Never, Inc., earns book net income before tax of $500,000. In computing its book income, Never deducts

$50,000 more in warranty expense for book purposes than is allowed for tax purposes. Never records no other

temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35% and no valuation

allowance is required, what is Never’s deferred income tax asset reported on its GAAP financial statements?

a. $192,500. b. $175,000. c. $157,500. d. $17,500.

____ 15. South, Inc., earns book net income before tax of $400,000 in 2010. South acquires a depreciable asset in

2010, and first year tax depreciation exceeds book depreciation by $50,000. At the end of 2010, South’s

deferred tax liability account balance is $17,500. In 2011, South earns $500,000 book net income before tax,

and its book depreciation exceeds tax depreciation by $20,000. South records no other temporary or

permanent book-tax differences. Assuming that the U.S. tax rate is 35%, what is South’s total income tax

expense reported on its GAAP financial statements for 2011?

a. $182,000. b. $175,000. c. $168,000. d. $7,000.





permanent book-tax differences. Assuming that the U.S. tax rate is 35%, what is South’s current income tax

expense reported on its GAAP financial statements for 2011?

a. $182,000. b. $175,000. c. $168,000. d. $7,000.





permanent book-tax differences. Assuming that the U.S. tax rate is 35%, what is South’s balance in its

deferred tax liability account at the end of 2011?

a. $17,500. b. $10,500. c. $7,000. d. $0.

____ 18. Larson, Inc., hopes to report a total book tax expense of $160,000 in the current year. This $160,000 expense

consists of $240,000 in current tax expense and an $80,000 tax benefit related to the expected future use of an

NOL by Larson. If the auditors determine that a valuation allowance of $30,000 must be placed against

Larson’s deferred tax assets, what is Larson’s total book tax expense?

a. $160,000. b. $130,000. c. $190,000. d. $240,000.

____ 19. Cold, Inc., reported a $100,000 total tax expense for financial statement purposes in 2010. This total expense

consisted of $150,000 in current tax expense and a deferred tax benefit of $50,000. The deferred tax benefit

consisted of $90,000 in deferred tax assets reduced by a valuation allowance of $40,000. In 2011, Cold

reports $600,000 in book net income before tax. Cold records no other permanent or temporary book-tax

differences for 2011. At the end of 2011, Cold’s auditors determine that the existing valuation allowance of

$40,000 should be reduced to zero. What is Cold’s total tax expense for 2011?

a. $210,000. b. $170,000. c. $250,000. d. $40,000.

____ 20. Beach, Inc., a domestic corporation, owns 100% of Mountain, Ltd., a manufacturing facility in Ireland.

Mountain has no operations or activities in the United States. The U.S. tax rate is 35% and the Irish tax rate is

10%. For the current year, Beach earns $500,000 in taxable income. Mountain earns $300,000 in taxable

income from its operations, pays $30,000 in taxes to Ireland, and makes no distributions to Beach. What is

Beach’s effective tax rate for GAAP book purposes, assuming that Beach does not make the permanent

reinvestment assumption of ASC 740-30 (APB 23)?

a. 38.75%. b. 31.25%. c. 35%. d. 25.63%.

____ 21. Beach, Inc., a domestic corporation, owns 100% of Mountain, Ltd., a manufacturing facility in Ireland.

Mountain has no operations or activities in the United States. The U.S. tax rate is 35% and the Irish tax rate is

10%. For the current year, Beach earns $500,000 in taxable income. Mountain earns $300,000 in taxable

income from its operations, pays $30,000 in taxes to Ireland, and makes no distributions to Beach. What is

Beach’s effective tax rate for GAAP book purposes, assuming that Beach makes the permanent reinvestment

assumption of ASC 740-30 (APB 23)?

a. 38.75%. b. 31.25%. c. 35%. d. 25.63%.

____ 22. Which of the following items are not included in the GAAP financial statement income tax note’s effective

tax rate reconciliation?

a. Hypothetical tax on book income at U.S. Federal corporate tax rate. b. Tax effect of permanent differences. c. Tax effect of temporary differences. d. Total tax expense per financial statements. e. None of the above is included in the note.

____ 23. Which of the following items are not included in the income tax note for a publicly traded company?

a. Breakdown of income between foreign and domestic.

b. Analysis of deferred tax assets and liabilities. c. Breakdown of income among States. d. Rate reconciliation. e. Analysis of total tax expense components.

____ 24. How are deferred tax liabilities and assets categorized on the balance sheet?

a. Capital and ordinary. b. Domestic and foreign. c. Current and non-current. d. Positive and negative.

____ 25. Hot, Inc.’s primary competitor is Cold, Inc. When comparing relative deferred tax asset and liability accounts

with Cold, which of the following benchmarking activities should Hot undertake?

a. Scale the deferred tax assets and liabilities by total sales or total assets. b. Compare raw dollar amounts of deferred tax assets and liabilities. c. Ignore deferred tax assets and liabilities and focus on overall effective tax rate. d. Ignore all tax information other than the current tax expense.

____ 26. Collins, Inc., reports an effective tax rate in its income tax footnote of 14%. The only reconciling item with

regard to the hypothetical tax at 35% is a valuation allowance reversal of negative 21%. Which of the

following statements is true concerning comparing Collins, Inc.’s effective tax rate with its competitors, all of

whom have an effective tax rate between 32 and 36%?

a. Collins Inc. is managing its tax burden in a more efficient manner than its competitors. b. Collins Inc. earned more cash profits because of its lower effective tax rate. c. Collins Inc.’s structural effective tax rate is actually quite close to its competitors. d. Collins Inc. is likely to be engaged in tax shelter activities.

____ 27. Which of the following statements best describes considerations regarding a company’s tax expense that may

be made by users of GAAP financial statements?

a. The breakdown of tax expense between current and deferred may provide useful

information regarding the comparison of tax burdens between companies. b. An analysis of earnings before interest, taxes, depreciation, and amortization (EBITDA) is

often a better approach to comparing operating results of two companies. c. One-time effects within a company’s effective tax rate should be removed before

comparing effective tax rates across companies (or across years for the same company). d. All the above observations are correct.

Problem

1. Kooler, Inc., is a domestic corporation. It owns 100% of Texas, Inc., a domestic corporation, 100% of Paris, a

foreign corporation, and 45% of Iowa, Inc., a domestic corporation.

a. Which entities’ incomes are included in Kooler’s combined GAAP financial statements? b. How would your answer change if Kooler instead owned 15% of Iowa?

2. Bunker, Inc., is a domestic corporation. It owns 100% of Texas, Inc., a domestic corporation, 100% of Paris, a

foreign corporation, and 35% of Iowa, Inc., a domestic corporation.

a. Which entities’ incomes are included in Bunker’s Federal consolidated income tax

return?

b. How would your answer change if Bunker instead owned 15% of Iowa?

3. Rochelle, Inc., reported the following results for the current year.

Book income (before tax) $500,000 Tax depreciation in excess of book 25,000 Non-tax-deductible warranty expense 17,500 Municipal bond interest income 20,000

Determine Rochelle’s taxable income for the current year. Identify any temporary or permanent book-tax

differences.

4. PaintCo Inc., a domestic corporation, owns 100% of BrushCo Ltd., an Irish corporation. Assume that the U.S.

corporate tax rate is 35% and the Irish rate is 10%. PaintCo is permanently reinvesting BrushCo’s earnings

outside the United States under ASC 740-30 (APB 23). The corporations’ book income, permanent and

temporary book-tax differences, and current tax expense are as follows. Determine PaintCo’s total tax

expense reported on its financial statements, its current tax expense (benefit), and its deferred tax expense

(benefit).

PaintCo BrushCo

Book income before tax $600,000 $400,000 Permanent differences Meals & entertainment expense 40,000 –0– Municipal bond interest income (100,000) –0– Temporary differences Tax > book depreciation (100,000) –0– Book > tax bad debt expense 20,000 –0–

5. PaintCo Inc., a domestic corporation, owns 100% of BrushCo Ltd., an Irish corporation. Assume that the U.S.

corporate tax rate is 35% and the Irish rate is 10%. PaintCo is permanently reinvesting BrushCo’s earnings

outside the United States under ASC 740-30 (APB 23). The corporations’ book income, permanent and

temporary book-tax differences, and current tax expense are as follows. Provide the income tax footnote rate

reconciliation for PaintCo using both dollar amounts and percentages.

PaintCo BrushCo

Book income before tax $600,000 $400,000 Permanent differences Meals & entertainment expense 40,000 –0– Municipal bond interest income (100,000) –0– Temporary differences Tax > book depreciation (100,000) –0– Book > tax bad debt expense 20,000 –0–

6. Gator, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of

the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit) Book Debit/(Credit)

Assets

Cash $ 300 $ 300 Accounts Receivable 5,000 5,000 Buildings 300,000 300,000 Acc. Depreciation (150,000) (80,000) Furniture & Fixtures 40,000 40,000 Acc. Depreciation (21,000) (15,000) Total Assets $174,300 $250,300

Liabilities

Accrued Litigation

Expense $ –0– ($ 27,000)

Note Payable (116,000) (116,000) Total Liabilities ($116,000) ($143,000)

Stockholder Equity

Paid in Capital ($ 1,000) ($ 1,000) Retained Earnings (57,300) (106,300) Total Liabilities and Stockholders Equity

($174,300)

($250,300)

Gator Inc.’s gross deferred tax assets and liabilities at the beginning of Gator’s year are listed below.

Beginning of Year

Accrued Litigation Expense $21,000 Subtotal $21,000 Applicable Tax Rate 34% Gross Deferred Tax Asset $ 7,140

Building – Acc. Depreciation ($61,000) Furniture & fixtures – Acc. Depreciation (3,200) Subtotal ($64,200) Applicable tax rate 34% Gross deferred tax liability ($21,828)

Gator Inc.’s book income before tax is $6,300. Gator records two permanent book-tax differences. It earned

$250 in tax exempt municipal bond interest and $460 in nondeductible meals and entertainment expense.

Determine the change in Gator’s deferred tax assets for the current year.




Assets

Cash $ 300 $ 300 Accounts Receivable 5,000 5,000 Buildings 300,000 300,000 Acc. Depreciation (150,000) (80,000) Furniture & Fixtures 40,000 40,000 Acc. Depreciation (21,000) (15,000)

Total Assets $174,300 $250,300

Liabilities

Accrued Litigation

Expense $ –0– ($ 27,000)


Stockholder Equity


($174,300)

($250,300)


Beginning of Year





Determine the net deferred tax asset or net deferred tax liability at year end.




Assets


Liabilities

Accrued Litigation

Expense $ –0– ($ 27,000)

Note Payable (116,000) (116,000)

Total Liabilities ($116,000) ($143,000)

Stockholder Equity


($174,300)

($250,300)


Beginning of Year





Determine the change in Gator’s deferred tax liabilities for the current year.




Assets


Liabilities

Accrued Litigation

Expense $ –0– ($ 27,000)


Stockholder Equity

Paid in Capital ($ 1,000) ($ 1,000) Retained Earnings (57,300) (106,300)

Total Liabilities and Stockholders Equity

($174,300)

($250,300)


Beginning of Year





Determine Gator’s change in net deferred tax asset or net deferred tax liability for the current year and

provide the journal entry to record this amount.




Assets


Liabilities

Accrued Litigation

Expense $ –0– ($ 27,000)


Stockholder Equity


($174,300)

($250,300)


Beginning of Year





Calculate Gator’s current tax expense.




Assets


Liabilities

Accrued Litigation

Expense $ –0– ($ 27,000)


Stockholder Equity


($174,300)

($250,300)


Beginning of Year





Provide the journal entry to record Gator’s current tax expense.




Assets Cash $ 300 $ 300 Accounts Receivable 5,000 5,000 Buildings 300,000 300,000 Acc. Depreciation (150,000) (80,000) Furniture & Fixtures 40,000 40,000 Acc. Depreciation (21,000) (15,000) Total Assets $174,300 $250,300

Liabilities Accrued Litigation Expense $ –0– ($ 27,000) Note Payable (116,000) (116,000) Total Liabilities ($116,000) ($143,000)

Stockholder Equity Paid in Capital ($ 1,000) ($ 1,000) Retained Earnings (57,300) (106,300) Total Liabilities and Stockholders Equity

($174,300)

($250,300)


Beginning of Year Accrued Litigation Expense $21,000 Subtotal $21,000 Applicable Tax Rate 34% Gross Deferred Tax Asset $ 7,140




What is Gator’s total provision for income tax expense reported on its GAAP financial statement and its book

net income after tax?




Assets Cash $ 300 $ 300 Accounts Receivable 5,000 5,000 Buildings 300,000 300,000 Acc. Depreciation (150,000) (80,000) Furniture & Fixtures 40,000 40,000 Acc. Depreciation (21,000) (15,000) Total Assets $174,300 $250,300

Liabilities Accrued Litigation Expense $ –0– ($ 27,000) Note Payable (116,000) (116,000) Total Liabilities ($116,000) ($143,000)


($174,300)

($250,300)


Beginning of Year Accrued Litigation Expense $21,000 Subtotal $21,000 Applicable Tax Rate 34% Gross Deferred Tax Asset $ 7,140




Provide the income tax footnote rate reconciliation for Gator.

14. Amelia, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end

of the year. Assume a 34% corporate tax rate and no valuation allowance.


Assets

Cash $ 1,200 $ 1,200 Accounts Receivable 20,000 20,000 Buildings 1,200,000 1,200,000 Acc. Depreciation (600,000) (320,000) Furniture & Fixtures 160,000 160,000 Acc. Depreciation (84,000) (60,000) Total Assets $ 697,200 $1,001,200

Liabilities

Accrued Vacation Pay $ –0– ($108,000) Note Payable (464,000) (464,000) Total Liabilities ($464,000) ($572,000)

Stockholder Equity


($697,200)

($1,001,200)

Amelia Inc.’s gross deferred tax assets and liabilities at the beginning of Amelia’s year are listed below.

Beginning of Year

Accrued Vacation Pay $84,000 Subtotal $84,000 Applicable Tax Rate 34% Gross Deferred Tax Asset $28,560

Building – Acc. Depreciation ($244,000) Furniture & fixtures – Acc. Depreciation (12,800) Subtotal ($256,800) Applicable tax rate 34% Gross deferred tax liability ($ 87,312)

Amelia Inc.’s book income before tax is $25,200. Amelia records two permanent book-tax differences. It

earned $1,000 in tax exempt municipal bond interest and $1,840 in nondeductible meals and entertainment

expense. Determine the change in Amelia’s deferred tax assets for the current year.




Assets

Cash $ 1,200 $ 1,200 Accounts Receivable 20,000 20,000 Buildings 1,200,000 1,200,000 Acc. Depreciation (600,000) (320,000)

Furniture & Fixtures 160,000 160,000 Acc. Depreciation (84,000) (60,000) Total Assets $ 697,200 $1,001,200

Liabilities


Stockholder Equity


($697,200)

($1,001,200)


Beginning of Year





expense. Determine the net deferred tax asset or net deferred tax liability at year end.




Assets


Liabilities

Accrued Vacation Pay $ –0– ($108,000) Note Payable (464,000) (464,000)

Total Liabilities ($464,000) ($572,000)

Stockholder Equity


($697,200)

($1,001,200)


Beginning of Year





expense. Determine the change in Amelia’s deferred tax liabilities for the current year.




Assets


Liabilities


Stockholder Equity


($697,200) ($1,001,200)


Beginning of Year





expense. Determine Amelia’s change in net deferred tax asset or net deferred tax liability for the current year

and provide the journal entry to record this amount.




Assets


Liabilities


Stockholder Equity


($697,200)

($1,001,200)


Beginning of Year





expense. Calculate Amelia’s current tax expense.




Assets


Liabilities


Stockholder Equity


($697,200)

($1,001,200)


Beginning of Year


Building – Acc. Depreciation ($244,000) Furniture & fixtures – Acc. Depreciation (12,800)

Subtotal ($256,800) Applicable tax rate 34% Gross deferred tax liability ($ 87,312)



expense. Provide the journal entry to record Amelia’s current tax expense.




Assets Cash $ 1,200 $ 1,200 Accounts Receivable 20,000 20,000 Buildings 1,200,000 1,200,000 Acc. Depreciation (600,000) (320,000) Furniture & Fixtures 160,000 160,000 Acc. Depreciation (84,000) (60,000) Total Assets $ 697,200 $1,001,200

Liabilities Accrued Vacation Pay $ –0– ($108,000) Note Payable (464,000) (464,000) Total Liabilities ($464,000) ($572,000)


($697,200)

($1,001,200)


Beginning of Year Accrued Vacation Pay $84,000 Subtotal $84,000 Applicable Tax Rate 34% Gross Deferred Tax Asset $28,560




expense. What is Amelia’s total provision for income tax expense reported on its financial statement and its

book net income after tax?




Assets Cash $ 1,200 $ 1,200 Accounts Receivable 20,000 20,000 Buildings 1,200,000 1,200,000 Acc. Depreciation (600,000) (320,000) Furniture & Fixtures 160,000 160,000 Acc. Depreciation (84,000) (60,000) Total Assets $ 697,200 $1,001,200

Liabilities Accrued Vacation Pay $ –0– ($108,000) Note Payable (464,000) (464,000) Total Liabilities ($464,000) ($572,000)


($697,200)

($1,001,200)


Beginning of Year Accrued Vacation Pay $84,000 Subtotal $84,000 Applicable Tax Rate 34% Gross Deferred Tax Asset $28,560




expense. Provide the income tax footnote rate reconciliation for Amelia.

22. At the beginning of the year, Jensen Inc., holds a net operating loss carryforward, and its balance sheet shows

a related deferred tax asset of $500,000. At the end of the year, the balance in the deferred tax asset account

has not changed, but Jensen’s auditors want to record a $100,000 valuation allowance against this amount,

because of a persistent downturn in Jensen’s profitability. Develop the journal entry to record the valuation

allowance.

23. At the beginning of the year, the balance sheet of Jensen Inc., shows a $500,000 deferred tax asset relating to

a net operating loss carryforward, offset by a $100,000 valuation allowance. At the end of the year, Jensen’s

auditors agree to release $40,000 of the allowance. Develop the journal entry to record this change in the

valuation allowance.

24. After applying the balance sheet method to determine the GAAP income tax expense of Cutter Inc., the

following account balances are found. Determine the balance sheet presentation of these amounts. Hint:

Which of the accounts should you combine for the final balance sheet disclosure?

Deferred tax assets, current $100,000 Deferred tax liabilities, current 115,000 Deferred tax assets, noncurrent 80,000 Deferred tax liabilities, noncurrent 30,000

25. After applying the balance sheet method to determine the GAAP income tax expense of Poppert Inc., the

following account balances are found. Determine the balance sheet presentation of these amounts. Hint:

Which of the accounts should you combine for the final balance sheet disclosure?

Deferred tax assets, current $200,000 Deferred tax assets, noncurrent 145,000 Deferred tax liabilities, current 80,000 Deferred tax liabilities, noncurrent 230,000

26. You are assisting LipidCo, a U.S. corporation subject to GAAP, to determine its current-year book expense

for income taxes. The following represent the steps that you will take in making this computation. Put the

steps into the correct order.

A. Compute the deferred tax provision. B. Decide whether a valuation allowance is required, and apply or release it. C. Determine book income before tax effects. D. Determine the current tax provision. E. Identify and measure temporary book-tax differences. F. Prepare the disclosures for the financial statement footnotes. G. Subtract permanent book-tax difference.

Essay

1. A corporation’s taxable income almost never is the same as its GAAP financial accounting income. Explain

why this occurs. Use the terms permanent and temporary book-tax differences in your answer. Give

examples of each.

2. Book-tax differences can be explained in part by examining the objectives underlying financial accounting

and taxable income computations. Evaluate this statement.

3. How does an auditor determine whether a valuation allowance is needed against an entity’s deferred tax

asset? List some of the factors than an auditor will consider in this regard.

4. Grant, a multinational corporation based in the U.S., has used ASC 740-30 (APB 23) to avoid reporting any

U.S. deferred tax expense on $70 million of the earnings of its foreign subsidiaries. All of these subsidiaries

operate in countries with lower tax rates than those of the U.S. When the profits eventually are repatriated,

how is Grant’s effective tax rate affected on its GAAP financial statements?

5. You are the tax adviser to a publicly traded U.S. corporation. How might you use a “benchmarking” analysis

to begin your review of the entity’s tax situation and planning opportunities?

Chapter 14

Answer Section

TRUE/FALSE

1. ANS: F

Permanent and temporary differences can trigger book tax differences.

PTS: 1 DIF: 1 REF: p. 14-5 OBJ: 1

NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min

2. ANS: F PTS: 1 DIF: 1 REF: Example 1

OBJ: 1 NAT: AICPA FN-Reporting | AACSB Analytic

MSC: 2 min

3. ANS: F

Foreign entities are not included, without regard to the parent’s level of ownership.

PTS: 1 DIF: 1 REF: Example 2 OBJ: 1


4. ANS: T

Under the equity method, the owner’s share of earnings must be included in its book income.



5. ANS: F

These subsidiaries are included only by taxpayer election.



6. ANS: F

The financial statement tax expense (provision) includes both Federal and state income taxes.

PTS: 1 DIF: 1 REF: Example 3 | Example 4


MSC: 2 min

7. ANS: T PTS: 1 DIF: 1 REF: p. 14-5


MSC: 2 min

8. ANS: T PTS: 1 DIF: 1 REF: p. 14-7 | p. 14-8


MSC: 2 min

9. ANS: F

The statement describes a temporary difference.



10. ANS: F

ASC 740 (SFAS 109) requires reporting both current and future tax costs (and benefits).



11. ANS: T PTS: 1 DIF: 1 REF: p. 14-9


MSC: 2 min

12. ANS: F

The statement describes a deferred tax asset.

PTS: 1 DIF: 1 REF: p. 14-10 OBJ: 2


13. ANS: F

Deferred tax liability is a tax to be paid in the future, associated with current book income.

PTS: 1 DIF: 1 REF: p. 14-10 OBJ: 2


14. ANS: T PTS: 1 DIF: 1 REF: p. 14-10


MSC: 2 min

15. ANS: F

Deferred tax asset is a future tax benefit associated with current book income.

PTS: 1 DIF: 1 REF: p. 14-10 OBJ: 2


16. ANS: F

The valuation allowance only reduces a deferred tax asset.

PTS: 1 DIF: 1 REF: p. 14-14 OBJ: 3


17. ANS: T PTS: 1 DIF: 1 REF: Example 11 | Example 12

OBJ: 3 NAT: AICPA FN-Measurement | AACSB Analytic

MSC: 2 min

18. ANS: F

The release of the valuation allowance reduces the corporation’s ETR.

PTS: 1 DIF: 1 REF: p. 14-27 OBJ: 3

NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min

19. ANS: T

ASC 740-30 (APB 23) allows a corporation to avoid reporting future U.S. tax costs (benefits).



MSC: 2 min

20. ANS: F

APB 23 can be used in some years and not others, and for some or all of the foreign earnings reported for the

year.



21. ANS: T

The U.S. tax on these earnings is included in the current tax expense but the associated income is not included

as it was previously included in the financial statements.



22. ANS: T

ASC 740-30 (APB 23) benefits occur only when the comparable U.S. tax rates are higher than those of the

other country.



MSC: 2 min

23. ANS: T PTS: 1 DIF: 1 REF: p. 14-19


MSC: 2 min

24. ANS: F

Only permanent differences show up in the rate reconciliation.



25. ANS: F

Temporary differences do not affect the ETR.

PTS: 1 DIF: 1 REF: p. 14-19 OBJ: 5


26. ANS: T

ASC 740 (FIN 48) imposes specific rules and procedures in determining whether a particular uncertain tax

position may be “booked” for GAAP purposes.

PTS: 1 DIF: 1 REF: p. 14-15 OBJ: 4


27. ANS: T

The ASC 740 (FIN 48) provisions replaced FAS 5 when adopted in July 2006. This provision significantly

changes the rules for accounting for uncertain tax positions.

PTS: 1 DIF: 1 REF: p. 14-15 OBJ: 4


28. ANS: F

The purpose is to match all the tax expenses (no matter when expected to be incurred) with the income

reported in the current year financial statements.



29. ANS: F

Current tax expense may differ considerably from actual taxes paid in any given year.

PTS: 1 DIF: 1 REF: p. 14-9 OBJ: 2


MULTIPLE CHOICE

1. ANS: A

The income of Blue and Yellow is included in the financial statements because Purple owns more than 50%

of these entities. Green’s operations are included as well, but under the equity method.



2. ANS: C

The income of Vinyl and Digital is included in Create’s financial statements because Create owns more than

50% of these entities. Record’s operations are not included because Create owned less than 20% of it, and the

equity method does not apply.



3. ANS: D

Only Yellow is eligible to be included in a consolidated return. Blue is a foreign entity and Green doesn’t

meet the 80% ownership test.



4. ANS: A

Only Digital is eligible to be included in a consolidated return. Vinyl is a foreign entity and Record doesn’t

meet the ownership test.



5. ANS: E

The financial statement income tax expense includes the income taxes associated with all taxing jurisdictions.



6. ANS: D

Only Federal income taxes are included in the income tax expense on the Federal tax return.



7. ANS: B

Only the compensation related expenses represent a temporary difference. All the other items are permanent

differences.

PTS: 1 DIF: 1 REF: p. 14-5 | p. 14-6


MSC: 5 min

8. ANS: B

The deferred tax expense is the difference between the beginning of the year and end of the year deferred

accounts. In this case the difference is $120,000 35%, producing a deferred tax liability of $42,000.

Taxable income is $480,000 ($600,000 – $120,000), producing a current tax expense of $168,000. The total

book tax expense is $168,000 + $42,000, or $210,000. The APB 11 shortcut method would produce the same

result.

Book income after permanent differences is $600,000. Consequently, total tax expense is $210,000 ($600,000

35%)



9. ANS: C

Taxable income is $480,000 ($600,000 – $120,000), producing a current tax expense of $168,000 ($480,000

35%).



10. ANS: D

The difference in book-tax basis in Clipp’s assets at year end is $120,000. Multiplied by the tax rate, this

produces a deferred tax liability needed of $42,000. The beginning of the year deferred tax liability was zero.

Thus the deferred tax liability for the year is $42,000. The APB 11 short cut method produces the same result.


35%). The current portion of this total tax expense is $168,000 [($600,000 – $120,000) 35%]. The

deferred tax liability is ($210,000 – $168,000 = $42,000).



11. ANS: B

The deferred tax liability is the difference in book and tax basis in the depreciable asset ($120,000) multiplied

by the corporate tax rate of 35% ($42,000 = $120,000 35%). Jogg has not created any deferred tax asset in

the current year.



12. ANS: B


35%).



13. ANS: A


35%). The current portion of this total tax expense is $192,500 [($500,000 + $50,000) 35%].



14. ANS: D


35%). The current portion of this total tax expense is $192,500 [($500,000 + $50,000) 35%]. The deferred

tax asset is the difference in book and tax basis, in the warranty expense ($50,000) multiplied by the corporate

tax rate of 35% ($17,500 = $50,000 35%).



MSC: 2 min

15. ANS: B


35%). The depreciation temporary difference does not affect the book tax expense.



16. ANS: A


35%). The current portion of this total tax expense is $182,000 [($500,000 + $20,000) 35%]. The

difference of $7,000 reduces the deferred tax liability from $17,500 to $10,500.



17. ANS: B


35%). The current portion of this total tax expense is $182,000 [($500,000 + $20,000) 35%]. The

difference of $7,000 reduces the deferred tax liability from $17,500 to $10,500.



18. ANS: C

$190,000 total book tax expense. The deferred tax asset of $80,000 must be reduced to $50,000 by the

$30,000 valuation allowance. Accordingly, the total tax expense is $190,000 ($240,000 current tax expense

less $50,000 deferred tax benefit).



MSC: 5 min

19. ANS: B

With $600,000 of book income, the potential total book tax expense is $210,000 ($600,000 35%). However,

the release of the $40,000 valuation allowance in the current year allows an additional $40,000 of future tax

benefits (savings) to be considered in the current year. Accordingly, the total tax expense for 2010 is

$170,000 ($210,000 – $40,000).

PTS: 1 DIF: 2 REF: p. 14-27 OBJ: 3


20. ANS: C

Beach’s total book income is $800,000. Its current U.S. income tax expense is $175,000 ($500,000 35%)

and its current Irish tax expense is $30,000. The deferred U.S. tax expense on the Irish earnings is $75,000

[($300,000 35%) – $30,000 FTC]. Thus, Beach’s total tax expense is $280,000 ($175,000 + $30,000 +

$75,000) and its ETR is 35% ($280,000/$800,000).

PTS: 2 DIF: 3 REF: p. 14-15 | p. 14-16


MSC: 10 min

21. ANS: D

Beach’s total book income is $800,000. Its current U.S. income tax expense is $175,000 ($500,000 35%)

and its current Irish tax expense is $30,000. Beach is not required to book any deferred U.S. tax expense on

the Irish earnings because of ASC 740-30 (APB 23). Thus, Beach’s total tax expense is $205,000 ($175,000 +

$30,000) and its ETR is 25.63% ($205,000/$800,000).

PTS: 1 DIF: 2 REF: p. 14-17 | p. 14-18


MSC: 10 min

22. ANS: C

Temporary differences do not affect the book tax expense or show up in the rate reconciliation.



23. ANS: C

The income tax note does not contain information on income earned in various U.S. states.

PTS: 1 DIF: 1 REF: p. 14-19 OBJ: 5


24. ANS: C PTS: 1 DIF: 1 REF: Example 18


MSC: 5 min

25. ANS: A

To compare the tax amounts properly, it is useful to scale these numbers by total assets or revenues. Raw

values may not be informative and a focus on only a portion of the tax information may be misleading.



26. ANS: C

The valuation allowance adjustment is likely a one-time event and should be backed out when comparing

Collins’ effective tax rate with its peers.



27. ANS: D

All of these items are typically considered in evaluating a company’s tax expense.

PTS: 1 DIF: 1 REF: Example 22 to 25


MSC: 5 min

PROBLEM

1. ANS:

a. Kooler includes its own net income and the net income of both Texas and Paris. In

addition, Kooler’s financial statements includes its 45% share of Iowa’s net income.

Kooler’s financial statement includes the income of these subsidiaries without regard to

whether Kooler receives any actual profit distributions from its subsidiaries. b. If Kooler instead owns 15% of Iowa, none of Iowa’s income is included in Kooler’s

financial statements until Iowa makes an actual dividend distribution to Kooler.



2. ANS:

Bunker includes its own taxable income and the taxable income of Texas if Bunker elects to include Texas in

its consolidated group. Paris is not included because foreign corporations are not eligible to be included.

Iowa’s income is not included because, although domestic, Bunker’s ownership percentage does not meet the

80% required level for tax consolidation.

If Bunker instead owns 15% of Iowa, the answer remains the same. None of Iowa’s income is included in

Bunker’s consolidated Federal income tax return until Iowa makes an actual dividend distribution to Bunker.



3. ANS:

Rochelle reports net income before tax of $425,000 on its GAAP financial statement, but it must adjust this

amount for book-tax differences . Tax depreciation in excess of book is a tax deduction not deducted for book

purposes, and warranty expense is deductible for book purposes but not yet deductible for tax. Both these

items are temporary differences because they eventually reverse (with book depreciation eventually exceeding

tax depreciation and the warranty expense ultimately deducted for tax when incurred). The municipal bond

adjustment is a permanent difference because this income never is subject to Federal income tax.

Book income (before tax) $500,000 Tax depreciation in excess of book (25,000) Non-deductible warranty expense 17,500 Municipal bond interest income (20,000) Taxable income (Form 1120) $472,500



4. ANS:

PaintCo BrushCo

Book income before tax $600,000 $400,000 Permanent differences Meals & entertainment expense 40,000 –0– Municipal bond interest income (100,000) –0– Book income after permanent differences $540,000 $400,000 Temporary differences Tax > book depreciation (100,000) –0– Book > tax bad debt expense 20,000 –0– Taxable income $460,000 $400,000 35% 10% Current tax expense $161,000 $ 40,000

The total tax expense is based on book income after permanent differences taking into account the APB 23

treatment of the foreign earnings [$229,000 = ($540,000 35%) + ($400,000 10%)]. The deferred tax

liability is increased by $28,000 for the year ($80,000 net temporary differences at 35%).

Current tax expense

Domestic $161,000 Foreign 40,000 Deferred tax expense Domestic 28,000 Foreign –0– Total tax expense $229,000



5. ANS:

PaintCo’s book income is $1,000,000 (the combined book income of both PaintCo and BrushCo). The

effective tax rate reconciliation is based on this book income, with the dollar amounts in the table representing

the tax expense (benefit) related to the item and the percentage representing the tax expense (benefit) as a

percentage of book income.

Effective tax rate reconciliation $ % Hypothetical tax at U.S. rate $350,000 35.0 Disallowed meals and entertainment expense 14,000 1.4 Municipal bond interest (35,000) (3.5) Foreign income taxed at less than U.S. rate (100,000) (10.0) Income tax expense (provision) $229,000 22.9

Note that only permanent differences appear in the rate reconciliation. Temporary differences do not affect

the total book income tax expense, they simply affect the amount of the tax expense that is current versus

deferred.



6. ANS:

Beginning of Year

Current Year

Difference

End of Year

Accrued Litigation Expense $21,000 $6,000 $27,000 Subtotal $21,000 $6,000 $27,000 Applicable Tax Rate 34% 34% Gross Deferred Tax Asset $ 7,140 $ 9,180

Change in Deferred Tax Asset $2,040



7. ANS:

Tax Debit/(Credit) Book Debit/(Credit) Difference

Assets Cash $ 300 $ 300 Accounts Receivable 5,000 5,000 Buildings 300,000 300,000 Acc. Depreciation (150,000) (80,000) ($70,000) Furniture & Fixtures 40,000 40,000 Acc. Depreciation (21,000) (15,000) (6,000)

Total Assets $174,300 $250,300 ($76,000)

Liabilities Accrued Litigation Expense

$ –0–

($ 27,000)

$27,000

Note Payable (116,000) (116,000) Total Liabilities ($116,000) ($143,000) $27,000

Stockholder Equity Paid in Capital ($ 1,000) ($ 1,000) Retained Earnings (57,300) (106,300) Total Liabilities & Stockholders Equity

($174,300) ($250,300)

Given these basis differences, the gross DTA and gross DTL are calculated as follows, with the net result a

DTL of $16,660.

Gross Deferred Tax Asset ($27,000 34%) $ 9,180

Gross Deferred Tax Liability ($76,000 34%) 25,840

Net Deferred Tax Liability $16,660



8. ANS:

Beginning of

Year Current Year

Difference

End of Year

Building – Acc. Depreciation ($61,000) ($ 9,000) ($70,000) Furniture & fixtures – Acc. Deprec (3,200) (2,800) (6,000) Subtotal ($64,200) ($11,800) ($76,000) Applicable tax rate 34% 34% Gross Deferred Tax liability ($21,828) ($25,840)

Change in Deferred Tax Liability ($ 4,012)



9. ANS:

Beginning of

Year Current Year

Difference

End of Year

Gross Deferred Tax Asset $ 7,140 $ 9,180

Change in Deferred Tax Asset $2,040 Gross deferred tax liability ($21,828) ($25,840)

Change in Deferred tax liability ($4,012) Net Deferred Tax Asset/ (Deferred Tax Liability)

($14,688) ($1,972) ($16,660)

The journal entry to record the deferred tax liability is as follows.

Income Tax Expense $1,972 Deferred Tax Liability $1,972



10. ANS:

Pre-tax Book Income $6,300 Book-Tax Adjustments

Permanent Items

Tax Exempt Income (250) Nondeductible M&E 460 Temporary Differences

Building Depreciation (9,000) Furniture & Fixtures Depreciation (2,800) Accrued Litigation Expenses 6,000 Taxable Income $ 710

Current Tax Expense $ 241



11. ANS:

Income Tax Expense $241

Current Income Tax Payable $241



12. ANS:

Book Net Income Before Tax $6,300 Provision for Income Tax Expense* (2,213) Net Income After Tax

* $241 + $1,972 = $2,213

$4,087



13. ANS:

$ %

Tax on Book Income at Statutory Rate 2,142 34.00 Tax Exempt Income (85) (1.35) Non-deductible Meals & Entertainment 156 2.48 Provision for Income Tax Expense 2,213 35.13

PTS: 2 DIF: 2 REF: Example 21 OBJ: 2 | 5


14. ANS:

Beginning of Year

Current Year

Difference

End of Year

Accrued Vacation Pay $84,000 $24,000 $108,000 Subtotal $84,000 $24,000 $108,000 Applicable Tax Rate 34% 34%

Gross Deferred Tax Asset $28,560 $ 36,720

Change in Deferred Tax Asset $ 8,160



15. ANS:

Tax Debit/(Credit) Book Debit/(Credit) Difference

Assets Cash $ 1,200 $ 1,200 Accounts Receivable 20,000 20,000 Buildings 1,200,000 1,200,000 Acc. Depreciation (600,000) (320,000) ($280,000) Furniture & Fixtures 160,000 160,000 Acc. Depreciation (84,000) (60,000) (24,000)

Total Assets $ 697,200 $1,001,200 ($304,000)

Liabilities

Accrued Vacation Pay $ –0– ($108,000) $108,000 Note Payable (464,000) (464,000) Total Liabilities ($464,000) ($572,000) $108,000

Stockholder Equity

Paid in Capital ($ 4,000) ($ 4,000) Retained Earnings (229,200) (425,200) Total Liabilities & Stockholders Equity

($697,200) ($1,001,200)

Given these basis differences, the gross DTA and gross DTL are calculated as follows, with the net result a

DTL of $66,640.

Gross Deferred Tax Asset ($108,000 34%) $ 36,720

Gross Deferred Tax Liability ($304,000 34%) (103,360) Net Deferred Tax Liability ($ 66,640)



16. ANS:

Beginning of

Year Current Year

Difference

End of Year

Building – Acc. Depreciation ($244,000) ($36,000) ($280,000) Furniture & fixtures – Acc. Deprec (12,800) (11,200) (24,000) Subtotal ($256,800) ($47,200) ($304,000)

Applicable tax rate 34% 34% Gross Deferred Tax liability ($ 87,312) ($103,360)

Change in Deferred Tax Liability ($16,048)



17. ANS:

Beginning of Year

Current Year

Difference

End of Year Gross Deferred Tax Asset $28,560 $ 36,720

Change in Deferred Tax Asset $ 8,160 Gross deferred tax liability ($87,312) ($103,360)

Change in Deferred tax liability ($16,048) Net Deferred Tax Asset/ (Deferred Tax Liability)

($58,752) ($ 7,888) ($ 66,640)

The journal entry to record the deferred tax liability is as follows.

Income Tax Expense $7,888

Deferred Tax Liability $7,888



18. ANS:

Pre-tax Book Income $25,200 Book-Tax Adjustments

Permanent Items Tax Exempt Income (1,000) Nondeductible M&E 1,840 Temporary Differences

Building Depreciation (36,000) Furniture & Fixtures Depreciation (11,200) Accrued Litigation Expenses 24,000 Taxable Income $ 2,840

Current Tax Expense $ 966



19. ANS:

Income Tax Expense $966

Current Income Tax Payable $966



20. ANS:

Book Net Income Before Tax $25,200 Provision for Income Tax Expense* (8,854) Net Income After Tax $16,346

* $966 + $7,888 = $8,854



21. ANS:

$ %

Tax on Book Income at Statutory Rate 8,568 34.00 Tax Exempt Income (340) (1.35) Non-deductible Meals & Entertainment 626 2.48 Provision for Income Tax Expense 8,854 35.13

PTS: 2 DIF: 2 REF: Example 21 OBJ: 2 | 5


22. ANS:

Income tax expense (provision), current year $100,000

Valuation allowance $100,000



23. ANS:

Valuation allowance $40,000

Income tax expense (provision), current year $40,000



24. ANS:

On its balance sheet, Cutter reports the following.

Deferred tax liabilities, current $15,000

Deferred tax assets, noncurrent $50,000



25. ANS:

On its balance sheet, Poppert reports the following.

Deferred tax assets, current $120,000

Deferred tax liabilities, noncurrent $ 85,000



26. ANS:

C. – G. – E. – D. – A. – B. - F.

PTS: 1 DIF: 1 REF: Concept Summary 14.2


MSC: 5 min

ESSAY

1. ANS:

Temporary differences are caused by income and expenses appearing in both the financial statement and tax

return, but in different periods (i.e., a timing difference). Permanent differences are caused by items appearing

in the financial statement or the tax return, but not both. Temporary differences do not affect the book total

tax expense. Temporary differences merely shift tax expense (benefit) between the current and deferred

accounts. Permanent differences do affect the total book tax expense and are identified in the tax footnote rate

reconciliation.

Examples of temporary differences include the following.

Depreciation on fixed assets.

Compensation related expenses where under GAAP, corporations must accrue the future

expenses related to providing postretirement benefits other than pensions (e.g., health

insurance coverage) but these expenses are deductible for tax purposes only when paid.

Warranty expenses accrued for book purposes but not deductible for tax purposes until

incurred.

Inventory write-offs accrued for book but not deductible for tax until incurred.

Net operating losses where operating losses from one tax year may be used to offset

taxable income in another tax year.

Goodwill is not amortizable for book purposes unless and until impaired.

Examples of permanent differences include the following.

Municipal bond interest income.

The disallowed portion of meals and entertainment expense.

Certain penalties.

Tax credits.

PTS: 2 DIF: 2 REF: p. 14-5 | p. 14-6


MSC: 15 min

2. ANS:

The purpose of the Federal tax return is to report the taxable income of an entity (or consolidated group) for

the tax year following U.S. tax law. A corporation’s financial statements are prepared in accordance with

GAAP. The ASC 740 (SFAS 109) approach produces a total income tax expense (also referred to as the

income tax provision) for the income currently reported on a corporation’s combined financial statement. This

approach follows the matching principle, where all the expenses related to earning income are reported in the

same period as the income without regard to when the expenses are actually paid.

The total book tax expense under ASC 740 (SFAS 109) is made up of both current and deferred components.

The current tax expense theoretically represents the taxes actually payable to (or refund receivable from) the

governmental authorities for the current period. The deferred component of the book tax expense is called the

deferred tax expense or deferred tax benefit. This component represents the future tax cost (or savings)

connected with income reported in the current period financial statement. Deferred tax expense or benefit is

created as a result of temporary differences.

PTS: 2 DIF: 1 REF: p. 14-7 | p. 14-8

OBJ: 1 | 2 NAT: AICPA FN-Reporting | AACSB Analytic

MSC: 10 min

3. ANS:

To determine whether a valuation allowance is required, both positive and negative evidence must be

evaluated. The key issue is whether the taxpayer will generate sufficient income (and tax liability) in the

future to use the deferred tax asset before any benefits expire. Examples of negative evidence (i.e., evidence

suggesting that the deferred tax asset will not be realized) include the following.

History of losses.

Expected future losses.

Short carryback/carryforward periods.

History of tax credits expiring unused.

Positive evidence (i.e., support for realizing the current benefit of future tax savings) include:

Strong earnings history.

Existing contracts.

Unrealized appreciation in assets.

Sales backlog of profitable orders.

Turnaround of temporary differences that produce future taxable income.

PTS: 2 DIF: 1 REF: p. 14-14 | p. 14-15


MSC: 10 min

4. ANS:

Because Grant used ASC 740-30 (APB 23) to avoid reporting any U.S. deferred tax liability for the $50

million of foreign subsidiary earnings, any repatriation of these profits back to the U.S. causes a spike

(increase) in the company’s book effective tax rate. The U.S. tax on these dividends (after any allowable

foreign tax credit) produces a current tax expense, but the book income will not include the dividends (as the

underlying profits were reported as book income in a prior year). With the numerator of the effective tax rate

fraction increasing and the denominator staying the same, the effective tax rate increases.

PTS: 2 DIF: 2 REF: p. 14-15 | p. 14-16


MSC: 10 min

5. ANS:

Companies may benchmark their tax situation to other years’ results or to other companies within the same

industry. The starting point for a benchmarking exercise is the data from the income tax note rate

reconciliation. When comparing effective tax rates it is important to consider which components of the

effective rate produce one-time effects and which components represent structural (long-lasting) effects. In

addition to comparing effective tax rates, companies can compare levels of deferred tax assets and liabilities.

PTS: 1 DIF: 1 REF: p. 14-25 to 14-27


MSC: 10 min

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