[JTGrass]

Pepitone Corporation buys equipment for $900,000 on January 1, Year One. Depreciation for book purposes is $300,000 per year. However, for tax purposes, depreciation was $500,000 in Year One and $200,000 in Year Two and $200,000 in Year Three. The enacted tax rate is 30 percent for Year One and Year Two but 32 percent for Year Three. Which of the following is found on the company’s balance sheet at the end of Year One?

A Deferred tax asset-current of $30,000 and deferred tax asset-noncurrent of $32,000

B Deferred tax asset-noncurrent of $62,000

C Deferred tax liability-current of $30,000 and deferred tax liability-noncurrent of $32,000

ANSWER: D Deferred tax liability-noncurrent of $62,000

I know it should be a NONCURRENT Asset/Liability, but I thought the answer should be (200,000 * .3) $60,000 Non-Current Asset if they are asking for Year 1. They paid $200,000 more for tax purposes so shouldn’t they have an Asset. I see where they get a liability of $62,000 (100,000*.3 & 100,000*.32) but why. What am I missing?

[joshuahuskers]

Because you have to use the enacted tax rate for the year the DTL is expected to reverse.

So you're correct in saying that there's 200,000 of taxable income out there that will reverse in the future. However, at the end of year two, there will still be a 100,000 temporary difference due to this piece of equipment. Accumulated depreciation for tax purposes will be 700,000 (500,000 year 1 + 200,000 year 2) and accumulated depreciation for book purposes will be 600,000 (200,000 in each of years 1 and 2)…so as you can see, only 100,000 (700,000 – 600,000) reversed in year two, when the enacted tax rate is 30%.

The remaining 100,000 will reverse in year 3 (when book depreciation is 300,000 and tax depreciation is 200,000), when the enacted rate is 32%, so you have to multiply that 100,00 by the 32% enacted rate in the year it will reverse.

So, the answer is 62,000 Long Term DTL. 100,000*30% for the part of the difference that reverses in year two when the enacted rate is 30%, and 100,000*32% for the portion of the difference that will reverse in year three, when the enacted rate is 32%. Long term because it's tied to a long-term asset, but you knew that.

Hope this helps.

AUD - 99 (7/31/12)
FAR - 90 (8/29/12)
REG - 10/2012
BEC - 10-11/2012

[joshuahuskers]

Errr, now I see I think I missed the point of your question, lol. It's a liability because they DEDUCTED 200,000 more in year one for tax than for book. The depreciation expense was 200,000 more in the current year…that's 200,000 more of income that they will have in the future, meaning they have to pay more taxes in the future, so it's a liability. Sorry for the mix up.

AUD - 99 (7/31/12)
FAR - 90 (8/29/12)
REG - 10/2012
BEC - 10-11/2012

[Whatdidyou]

Yes, if deductions > expenses or NI > TI, there is a DTL.

If expenses > deductions or TI > NI, there is a DTA. You are paying more actual tax now which benefits you in the future. In a way, you're sort of prepaying your tax as when you look solely at NI you owe less than what you are actually paying.

This question is a little wierd, thanks for posting it. Otherwise I would've assumed that you'd use a longer term enacted tax rate for a non-current DTA(L).

REG - Passed!!
BEC - Passed
FAR - Passed
AUD - Passed

Study Materials: Becker basic course

[Author]

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