In the answer below, where do the 4,657 and $2,755 numbers come from? 12,676 * 0.35 = 4,436 not 4,657… ??? 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 $747 B) $1,572 $507 C) $1,039 $507 D) $1,039 $747 Your answer: B 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).
Depreciation on SL: 2535 NI = 7192 - 2535 = 4657 Depr Tax basis: 4437 NI 7192 - 4437 = 2755 And tax difference = ( 4657 - 2755 ) *.31 == DTL HTH CP
cpk123, i bet you will be close to perfect score on FSA! It’s impressive how effortlessly you tackle every problem.
agreed… CPK…Didn’t you say you took the Lvl 1 exam in June and failed? If so, how could that be?
I think cpk is going to break all records this Dec 07 … 100% for the first time ever 240/240 - Dinesh S
I thank you all for your vote of confidence… but do not know if I can continue into the exam… and given CFAI and my propensity to guess, 240/240 is a very extremely long shot. never happened before, and will not definitely happen
lola would say, you’re on a roll cpk… nice work.