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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?
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:
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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