On its financial statements for the year ended December 31, 2004, Jackson, Inc. listed $2,000,000 in post retirement benefits expense. Jackson, Inc. contributed $200,000 of the expense to its retirement plan in 2004. Tax law recognizes cash contributions to a pension account as tax deductible, but not expense accruals. Jackson’s tax rate is 40 percent. For the year ended December 31, 2004, Jackson, Inc. should show, based on the above transaction, an increase in its deferred tax: A) asset account of $720,000. B) asset account of $800,000. C) liability account of $80,000. D) tax liability account of $720,000. Your answer: A was correct! Jackson’s $2,000,000 post-retirement benefits expense will create a decrease in income tax expense of ($2,000,000 * 0.40 =) $800,000. Income taxes payable will decrease ($200,000 * 0.40 =) $80,000. The difference is an increase in the deferred tax asset account of ($800,000 - $80,000 =) $720,000. MY QUESTION IS: WHY DOES THE 2, 000,000 CREATE A DECREASE IN INCOME TAX EXPENSE? IT SAYS: TAX LAW RECOGNIZES CASH CONTRIBUTIONS TO A PENSION ACCOUNT AS TAX DEDUCTIBLE, BUT NOT EXPENSE ACCRUALS…SO WHICH IS A TAX DEDUCTION: THE 2,000,000 OR THE 200,000? WHY IS THIS A DEFERRED TAX ASSET IF INCOME TAX EXPENSE = 800,000 AND TAXES PAYABLE = $80,000? I THOUGHT A DTA = TAXABLE INCOME IS LESS THAN PTI, HENCE TAXABLE INCOME IS LESS THAN INCOME TAX EXPENSE… I’M CONFUSED ON THIS QUESTION, WHICH IS FROM A SAMPLE EXAM. ANYTHING HELPS. Y
how did you answer it correctly if you didn’t understand the concepts?.. I think the thing you have to realize is the what is DTA and DTL…DTA is when your tax payable (or cash taxes paid) > income tax expense (b/c tax deductible < expense used in income statement), whereas DTL is when your tax payable < income tax expense (b/c tax deductible > expense used in income statement). So in this case, since the comp cannot use the full amount it accrued in the income statement for tax purposes, so it paid more taxes than its income statement would indicate, so the DTA helps to bring taxes paid down to reflect this fact for income tax expense
Step back from the question and reread/review the concept of deferred taxes. DTAs/DTLs come from the fact that when you fill out a tax return, it doesn’t always much up in amount line by line with your income statement, because od timing or permanent differences. Saying that you accrue (record) and expense in one amount and report for tax purposes another amount is the most basic example of what gives rise to a DTA or DTL.