I guessed B. Reasoning is that the tax return for the year will show only 4,000 (10,000*0.8) in tax payed for the lease. The remaining for 4,000 will need to be paid in the future and hence a DTL should be created on the accnt statement. Where am I going wrong? It’s a mulipart question. I just posted the one i had trouble with. Explanation given which didn’t make sense to me. (Since only $10,000 of the rent expense will be allowed per tax returns, a deferred tax asset of $4,000 will result ($10,000 × 40%). )
On the tax return for the year, only 10000 expense is deductible. 10000*0.4=4000
In the Income statement, the total rent expense recognized is 20,000. 20000*0.4=8000.
Therefore, the taxable income you get is 400,000-10,000=39,000. On the pretax income is 400,000-20,000=38,000. In this case, expense is recognized in the I/S before it is tax deductible. Therefore a DTA is created.
I figure since that since the tax accounting is on cash basis, we need to add 10,000 to the tax base making it a total of 410,000 which is higher than the pre tax income of 400,000, hence a DTA.
The reason why it’s an asset not a liability is because this is an expense not an income.
So, for income statement purposes, they have 20k rent expense but for tax they only have 10k expense.
In other words, their tax payable is more than for income statement’s tax expense and hence actual tax paid is more than tax expense on income statement.
First: the tax-free interest is irrelevant; that leads to a permanent difference between financial income and taxable income, and permanent differences don’t give rise to DTAs or DTLs.
For the rent expense, the $10,000 that is accrued but not paid ($20,000 – $10,000) is not deductible for income taxes; this is a temporary difference that will create a DTA or DTL. To determine which one it is, look at future taxes: they’ll be lower when you get to deduct the remainder of the rent. Lower future taxes is a benefit; future benefits are called assets: DTA. The amount is the temporary difference – $10,000 – times the tax rate: 0.40 × $10,000 = $4,000.
right so wouldn’t fin statement (pretax income) be 400 *.4 = 160 alloated to be paid in tax and tax return (taxable income) be 390*.4 which is 156 paid in tax?
in your exlainaton, you subtract the 20 from the 400 for the interest expense for the financial statement but I thought that was already included in the calculation of 400 so that is your pretax income
I didn’t subtract the 20 from the 400; I merely said that the 20 was an expense on the income statement. If it’s already included in the 400, there’s no reason to subtract it again.
If everything else on the tax return and the income statement were the same, then taxable income (on the tax return) would be 410: you get to subtract the $10k paid, not the $20k accrued. Thus, taxes payable would be 410*0.4 = 164. Higher taxes today leads to lower taxes in the future; lower future taxes is a future benefit: asset: DTA.
Pretax income of 400 includes the expense of 20; thus, income before this expense is 420. Taxable income includes an expense of only 10; thus, it’s 420 – 10 = 410. Taxable income has to be higher than pretax income because taxable expenses are lower than accounting expenses (in this example).