Hi all, Can someone plz help me understand these 2 questions. (1) For the first question - I thought the DTL for the first year would be based on 40% tax, and the 2nd year based on 50% thus yielding DTL of 9000 (4000 first year and 5000 2nd year) - 9000 is not on the answer choice. (2) For the second question - Please help understand why increase in deferred tax = (10,000 - 4,000). I know where --------------------------------------------------------------------------------------------------------------- • A Brill acquires an asset for $120,000 with a 4-year useful life and no salvage value. • The asset will generate $50,000 of cash flow for all four years. • The tax rate is 40% each year. • The firm will depreciate the asset over three years on a straight-line (SL) basis for tax purposes and over all four years on a SL basis for financial reporting purposes. Suppose tax rates rise during year 2 to 50%. At the end of year 2, the firm’s balance sheet will show a deferred tax liability of: A. $5,000. B. $6,000. C. $8,000. D. $10,000. D The deferred tax liability is now $20,000 x 50% = $10,000. (Multiply the cumulative income difference by rhe new tax rare.) Suppose tax rates rise during year 2 to 50%. What will be the income tax expense in year 2? A. $5,000. B. $8,000. C. $10,000. D. $11,000. D Taxes payable in year 2 is now taxable income x 50% = $10,000 x 50% = $5000. The deferred rax liability at the end of year 1 was $4,000 (before restatement under the new tax rates). Tax expense = taxes payable + increase in deferred taxes = $5,000 + ($10,000 - $4,000) = $11,000.
DTL and DTA’s are based off of future tax rates
Question 1: In the first year, depreciation expense is 40K on the income statement, only 30k on the tax report, creates a temporary difference of 10K which creates a DTL of 10k*40%=4K The second year the tax rate changes, and the previous DTL have to be restated: (4k/40%)*50%=5k Have the same temporary difference of 10k from depreciation, that creates a DTL of 10k*50%=5K Total DTL=10k, answer is D Question 2: on the tax report, Revenue:50k Depreciation:40k Taxable income=50k-40k=10k Taxes payable:10k*50%=5k Income Tax Expense (on the income statement) = Taxes Payable (from the Tax Return) + Changes in Deferred Tax Liabilities – Net Changes in Deferred Tax Assets In the first year, DTL were 4k, in the second year, DTL were 10k, a change in DTL of 6k Income tax expense=5k+6k=11k
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So everytime the tax rate changes you have to go back and recalculate all DTL’s and DTA’s in prior years to compute this yr’s temporary differences?
To calculate the DTL generated in a specific year, you look for the the temporary differences that year and apply the statutory tax rate to find DTL or DTA generaed that specific year. To calculate the DTL/DTA, as of that year, you need to go back and restate previous year’s DTL/DTA. To calculate the income tax expense, you consider only the change in DTL and the net change in DTA from year to year. No need to go back for all previous years, only one year (since each year DTL/DTAs are restated.
Okay so if the question asked for the DTL for yr 2 (specific yr) why isn’t the answer A? Or is it 10k because it asks for the number on the balance sheet (cumulative)? Suppose tax rates rise during year 2 to 50%. At the end of year 2, the firm’s balance sheet will show a deferred tax liability of: A. $5,000. B. $6,000. C. $8,000. D. $10,000.
It is cumulative, it asks for the BS DTL, not for the DTLs created during that year.
okay that’s what I thought, thanks for the help
Thanks. It was a great help!
Map1 - thanks for top notch explanation!
sbtrader Wrote: > > • A Brill acquires an asset for $120,000 with a > 4-year useful life and no salvage value. > • The asset will generate $50,000 of cash flow for > all four years. > • The tax rate is 40% each year. > • The firm will depreciate the asset over three > years on a straight-line (SL) basis for > tax purposes and over all four years on a SL basis > for financial reporting purposes. > > Suppose tax rates rise during year 2 to 50%. At > the end of year 2, the firm’s > balance sheet will show a deferred tax liability > of: > A. $5,000. > B. $6,000. > C. $8,000. > D. $10,000. > > D The deferred tax liability is now $20,000 x 50% > = $10,000. (Multiply the cumulative > income difference by rhe new tax rare.) > > Suppose tax rates rise during year 2 to 50%. What > will be the income tax > expense in year 2? > A. $5,000. > B. $8,000. > C. $10,000. > D. $11,000. > > D Taxes payable in year 2 is now taxable income x > 50% = $10,000 x 50% = $5000. The > deferred rax liability at the end of year 1 was > $4,000 (before restatement under the new > tax rates). Tax expense = taxes payable + increase > in deferred taxes = $5,000 + ($10,000 - $4,000) = > $11,000. Yr1 Tax Expense = Yr1 Pretax Income x Yr1 Tax Rate = $20K x 40% = $8K Why would it be wrong to apply the same to Yr2? Yr2 Tax Expense = Yr2 Pretax Income x Yr2 Tax Rate Yr2 Pretax Income = Revenue - Annual Depre. Expense (for financial reporting purposes) = $50K - $30K = $20K Yr 2 Tax Rate rises to 50% Yr2 Tax Expense = $20K x 50% = $10K
what happened to the prior period DTL that was originally calculated with a tax rate of 40% but now became 50%. year 1 DTL was 4K 4/.4 * .5 = 5K is the new changed DTL. you had already shown a DTL of 4K in the previous year. so now you have a change in DTL of 1K which needs to get added to the tax expense calculated above. so the tax expense = 10K + 1K = 11K.
Thanks, CP. Your way of thinking works for me. I’d rather not to mix with tax payable. Instead, calculate the target year tax expense + change in DTL (and - change in DTA if any?)
Easiest way to think of it as: Multiply the cumulative income difference by the new tax rate. 10k income from yr 1 + 10k income from yr 2 * .5 (new tax rate) = new DTL balance on the balance sheet