# Deferred Taxes

A Firm acquires an asset for \$120K with a 4-year useful life and no salvage value. The asset will generate \$50K of cash flow for all four years. The tax rate is 40% each year. The firm will depreciate the asset over 3 years on a straight line basis for tax purposes and over all four years on a straight line basis for financial reporting purposes. Suppose tax rates rise during year 2 to 50%. What will be the income tax expense in year 2? A. \$5k B. \$8k C. \$10k D. \$11k

D 11K A Firm acquires an asset for \$120K with a 4-year useful life and no salvage value. The asset will generate \$50K of cash flow for all four years. The tax rate is 40% each year. The firm will depreciate the asset over 3 years on a straight line basis for tax purposes and over all four years on a straight line basis for financial reporting purposes. Suppose tax rates rise during year 2 to 50%. What will be the income tax expense in year 2? A. \$5k B. \$8k C. \$10k D. \$11k FS Depr: 120 / 4 = 30K Year 2 Tax statement: 40 K Year 1: Tax Statement: Tax Payable: ( 50 - 40 ) * .4 = 4 K FStatement: Tax : ( 50 - 30 ) * .4 = 8 K DTL = 4 K Year 2: Tax Statement : Tax payable = (50 - 40) * .5 = 5K Fstatement: Tax: (50 - 30) * .5 = 10 K Delta DTL (Year 2)= 5 K Add on Delta DTL due to change of Tax rate = 1 K ( 4/.4 * .5 - 4 = 1 K) Tax expense in year 2: Tax Payable + Delta DTL = 5 + 5 + 1 = 11 K

I know, I did some sleuthing and found your original answer to this. Thanks!

cpk, I understand until the point that yr 1 DTL is 4K and yr2 DTL is 5K. Isn’t the Where does the additional 1 K coming from? Please explain. Thanks.

maparam Wrote: ------------------------------------------------------- > cpk, I understand until the point that yr 1 DTL is > 4K and yr2 DTL is 5K. Isn’t the Where does the > additional 1 K coming from? Please explain. > Thanks. the DTL in year 2 will be 10,000 under the tax rate of 50%(here we should use the cumulative difference after two years, i.e. 20,000, to calculate DTL), so the delta DTL will be (10,000-4,000)=6,000 Tax expense=Tax Payable + Delta DTL =5,000+6,000=11,000

the additional 1K comes from the difference of tax rate when recalculate Year 1’s DTL