* A firm acquires an asset for $ 120,0000 with a 4-year useful life and no salvage value. * The asset will generate $50,000 of cash flow for all 4 years. * The tax rate is 40% each year. * The firm will depreciate the asset over 3 years on a straight-line (SL) basis for tax purposes and over all 4 years on a SL 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. $5000 B. $8000 C. $10000 D. $11000
ans d: 11000 SL: Depr Exp: 30000 Accelerated: Depr Exp: 40000 Year 1**** DTL: (40000 - 30000) * .4 = 4000 In Year 2: DTL = (40000 - 30000) * .5 = 5000 Change in DTL of Year 1: 4000 / .4 * .5 = 1000 Year 2 Tax Payable: ( 50000 - 40000 ) * .5 = 5000 Total : 11000 CP
cpk123, why do you add DTL to the tax expense for the year? The tax expense shows up on the income statement for the period, whereas DTL is a balance sheet item, not relevant in this case. I could be wrong, I’m just not sure I follow.
Income Tax Expense = Income tax payable (from the Financial Statements) + Delta DTL - Delta DTA That’s why… The DTL component has two parts to consider 1. DTL for the current year 2. Change in DTL due to change in the Tax rate (for prior accumulated DTL). CP
That makes sense, and I certainly didn’t know that’s how it’s calculated! Is the answer D, cfanewyorker?
If I am not mistaken there is the same problem in the Schweser notes at the end of the chapter…
This question is asking about income tax expense; however, we all seem to be trying to calculate income tax payable. Are these two the same?
I was calculating Income tax expense. Income tax payable shows up on the Income statement (Financial statement) Income tax expense – shows up on the Tax statement (what is owed to the IRS). CP
Hi, cpk123. As far as I can tell, income tax payable is a liability and belongs on the balance sheet. Income tax expense is a flow and belongs on the income statement. Guess I am still a little confused.
The formula Income tax expense = Income tax payable + Delta DTL - Delta DTA is present in the books. The two are related, and this is a must know formula if you haven’t already encountered it. What you have said, one is a liability, one is a Income statement item, and is a flow item is all correct, but they do not and should not exist in isolation. The above is the means by which they are related. CP
Thanks CPK. 11000 is the correct answer and yes, it is in schweser. I was not able to understand the schweser explanation. You explained it quite well, thanks. Just for record, income tax expense is the expense recognized on the income statement and income taxes payble are the tax liability on the balance sheet caused by taxable income. Income tax paid is the actual flow for income taxes, including payments or refunds for other years.
cpk123 Wrote: ------------------------------------------------------- > I was calculating Income tax expense. > > Income tax payable shows up on the Income > statement (Financial statement) > > Income tax expense – shows up on the Tax > statement (what is owed to the IRS). > > CP I think you’re getting yourself a bit confused with terminology. Just to clarify: When a company calculates its income tax expense and payable (assuming that they will show the exact same figures on their income statement and tax return, and no estimates paid during the year, etc.) the entry is Tax expense $xxx (appears on the income statement) Taxes payable $xxx (appears on the balance sheet) When there are book/tax differences such as diff depreciation methods, the tax payable number goes down (up), and a deferred tax liability (asset) is recorded on the balance sheet. When you do a catch-up adjustment to the deferred account because of the effect of a change in tax rates on future tax payments you debit or credit the deferred account as appropriate, and run the other side of the entry thru income tax expense on the income statement. In a complex tax calculation, there is no single line item which reflects what shows up on the tax return… it usually is a combination of the basic entry above, plus/minus some or all of the reversals of amounts in the deferred accounts.
Thanks Super for clarifying. I was getting confused between the Income statement and the Balance sheet definitely. (Too long away from the books effect). CP