A company acquires some state-of-art production equipment at a net cost of $14*10^6. For financial reporting the company will depreciate the equipment over a 7-year life using straight line depreciation and a 0 salvage value; for tax purposes the firm will use a 3-year accelerated depreciation. Given a tax rate of 35% and a first year accelerated dep. factor of 0.333, by how much will the company’s deferred tax account increase in the 1st year of the equipment’s life? a) 931,700 b) 1,064,800 c) 1,730,300 d) 2,662,000

A?

FR --> Depreciation Expense = (14M - 0)/7 = 2m (end of year 1) TR --> Depreciation Expense = 14m * 0.33 = 4.662 (end of year 1) Difference = (4.662 - 2) = 2.662 2.662 * (1 - 0.35) = 1.730300 is it C?? - Dinesh S

Dinesh isn’t what you calculated the change in net income not the change in deffered taxes?

ya it should be A

Yes It should be A. I did a mistake of multiplying it by 1 - taxRate, Thanks florinpop !! It should be 2.662 * (0.35) = 0.9317 - Dinesh S

It seems to be A, and the logic behind it (not 100% sure) is that tax for the year will be calculated based on the $4.62M accelerated depreciation, and that’s what will appear on the income statement. Since they paid less taxes than otherwise they would have paid based on the $2M straight-line depreciation, the difference ($2.62M) will go into Deferred Taxes liability. Is this the correct logic? Dreary

Is the $2.62M the Deferred Tax Liablitity or is the $931,700 the DTL?

$931,700

$2.66M is the difference between the 2 depreciation method, DTL = 35% * $2.66M = $931,700

answer is A - congrats