Becker MCQ DTL and Installment Sales

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    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?



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  • #434947 Reply

    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.

    #434948 Reply

    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.

    #3315168 Reply

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

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