[Anonymous]

Becker MCQ: DTL and Installment Sales

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 3. The enacted tax rates are 30% in Year 1 and 25% in Year 3. In its Year 1 income statement, what amount should Shear report as deferred income tax expense?

a. $300
b. $360
c. $780
d. $650

The correct answer is A. Bad Debt Expense is considered as a DTA and the Profit from Installment Sales as a DTL. So,
2,600 – 1,400 = 1,200 x 25% = $300

I understand why Bad Debt Expense is a DTA, but why is Installment Sales considered as a DTL?

Let’s assume we have a Gross Profit Margin of 25%, collection of $250,000 for the year, and total gross profit of $100,000. Gross profit earned for the year (the amount that will be recognized) will be $250,000 x 25% = $62,500 and the amount deferred will be $100,000 – $62,500 = $37,500. So for our tax and book earnings, the amount will be:

Tax: $250,000

Book: $62,500. (Since only this amount will be recognized.)

As a result, the amount of taxes for tax purposes will be greater than the amount for book purposes….wouldn’t this result in a DTA instead?

Thanks!

 

 

[titine]

You need to consider the future tax liability/expense, not the current one. In future you will recognize more income on the book, so more tax expense >> DTL.

[Anonymous]

Accrued basis on the book, and Installment on tax, Accrued basis will recognize more income from the book earlier than installment on tax, those early income from book will be a deferred tax liability because it is taxable in the future for sure.

Same as percent-completed contract on book, and completed contract on tax, income from book will recognized earlier than tax income.

[C]

I understand the DTL part, but where in the question does it say that the Bad Debt expense will reverse in year 3??

[Author]

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