Deferred Taxes

Indata Company sold a specially manufactured item for $5,000,000 on December 31, 2006. The item was sold on an installment sale basis, with $1,000,000 paid on the date of the sale and $4,000,000 to be paid in four annual installments of $1,000,000 plus interest at the market rate of 6 percent. Indata’s tax rate is 40 percent and its costs to construct the item were $2,500,000. Indata recognizes the entire amount of the sale as income on the date the sale is made for accounting purposes, but not until cash is received for tax purposes. On its balance sheet dated December 31, 2006, Indata will, as a result of the transaction described above, increase its deferred tax: A) liability by $200,000. B) asset by $800,000. C) asset by $200,000. D) liability by $800,000.

DTL so A or D

For accounting purposes: Revenue = 5mil COGS=2.5mil Income=5-2.5=2.5mil For taxes purposes: Revenue=1mil COGS=20% (because of 5 installments)*cost too produce the item=20%*2.5mil=0.5mil Taxable income=1-0.5=0.5mil The difference between the income for accounting purposes and the taxable income is a temporary difference, resulting in a lesser tax payable on the lower taxable income, therefore a deferred tax liability. The temporary difference is 2.5-0.5=2mil, at 40%=0.8mil. Answer must be D.

D is correct…