# Deferred Tax Liability

A company purchased a new pizza oven directly from Italy for \$12,676. It will work for 5 years and has no salvage value. The tax rate is 41 percent, and annual revenues are constant at \$7,192. For financial reporting, the straight-line depreciation method is used, but for tax purposes depreciation is accelerated to 35 percent in years 1 and 2, and 30.00 percent in year 3. For purposes of this exercise ignore all expenses other than depreciation. Assume the tax rate for years 4 and 5 changed from 41 percent to 31 percent. What will be the deferred tax liability as of the end of year 3 and the resulting adjustment to the net income in year 3 for financial reporting purposes due to the change in the tax rate? Deferred Tax Liability Net Income A) \$1,572 \$507 B) \$1,572 \$747 C) \$1,039 \$507 D) \$1,039 \$747 Please provide explaination… i just not able to understand this… Thanks,

I got \$1039 for the DTL… not sure how to adjust NI for year 3. Am I right for the DTL? I can explain that far, but it’s going to take a long time, and I’d rather not try to explain if I’m wrong

Reading this question alone takes 2-3 minutes, doubt this long and length questions will come. start with 12676 SL dep on Financial books : 2535.20 so NI = (7192 - 2535.20)*.59 == 2749.4 Dep in IRS for yr1: 4436.6 DTL1 = (4436.6 - 2535.20) *.41 DTL1 = 779 Dep2: (12,676-4436.6)*.35 DTL2: ((12,676-4436.6)*.35 - 2535.20)*.41 + DTL1 work it out man… now … freaking a… takes forever to do this. but it can be done.

Hey Pepp are you sure the Tax Depreciation is correct? I assume each year’s depreciation is just the % times cost, not % times (cost - accumulated depr’n) - As it makes sense to see that the three years totals to full depreciation of 100% (35 + 35 + 30) however, using this way, i see a total DTL of 2078 (surprisingly double the 1039). I always assume the DTL is basically the accumulated tax liability owed from years one to three (accting deprn less tax depren). needcfa, do u have solutions to this?

I agree this one takes for ever to do it… Here the solution… Your answer: A was correct! Deferred tax liability at the end of year 3, after the change in tax rate will be \$1,572 = (\$589.62 + \$589.62 + \$393.08) Deferred Tax liability for year 1 = \$589.62 [(\$4,657 - \$2,755)(0.31)] Deferred Tax liability for year 2 = \$589.62 [(\$4,657 - \$2,755)(0.31)] Deferred Tax liability for year 3 = \$393.08 [(\$4,657 - \$3,389)(0.31)] The deferred tax liability will decrease by \$507 = (\$2,079 - \$1,572) due to the new lower tax rate. An adjustment of \$507 in tax expense will result in increase in net income by the same amount \$507. Deferred tax liability at the end of year 3 with tax rate of 41% = \$2,079 Deferred tax liability at the end of year 3 with tax rate of 31% = \$1,572 Another way of answering this question is as follows: The deferred tax liability is the cost of the oven multiplied by the difference in the amount of depreciation at the end of year 3 between accelerated depreciation (100%) and straight line (60%) depreciation methods multiplied by the tax rate ((12,676 x .4) x .31 = \$1,572). The change in net income due to the change in tax rates is the cost of the oven multiplied by the difference in the amount of depreciation at the end of year 3 multiplied by the difference in tax rates (12,676 x .4 x (.41 - .31) = 507).

I gotta be blind. If the machine costs 12676 and has 5 yrs to depreciate, yearly SL is 2535. why is the solution showing 2755?? And also why is the solution showing that depreciation in the tax return is same every year? If accelerated depreciation is used, isn’t it the second year’s depreciation is based of the book value of the machinery after 1st years depreciation has been taken out… The solution seems to oversimplify this problem by making their own assumptions.

Pepp, The 2755 is the net income using the Accelerated Dep Method. This is the same for year one and 2 but then changes in year three. The 4657 (7191-2535) in the net income using the stright line deprecitaion. The difference between the NI of the two methods (times the tax rate) creates your tax liability.