FSA Q........!!!

adance club purchased new sound equipment for $25352. it will work for 5 years and has no salvage value. thier tax rate is 41 percen, and their annual revenues are constant at $14384. for financeial reporting, the SL depreciation method is used, but for tax purposes depreciation is accelerated to 35 percent in year 1 and 2 and 30 percent in year 3,. for purposes of this exercise ignore all expenses other than depreciation Q1 assume that the tax rate changes for ear 4 and 5 from 41 percent to 31 persent. what will be the deferred tax liability as of the end of year three? 1)3144 2)2948 3)1443 4)1039 Q2 because the tax rate changes for year 4 and 5 from 41 percent to 31 percent, net income will have to be adjusted for financial reporting purpose in year three. what is the amount of this adjustment? 1)747 2)1030 3)1014 4)1909 any ideas??? explanation provided would be appreciated!!! ans: 3144, 1014

Good to know but I hope nothing like this on the exam to be solved in 90 secs.

Since the tax rate changes from 41 to 31, you need to adjust your DTLs and DTAs by the percent change in the tax rate on the B/S. In this example, the rate changes 31/41 - 1 = -24.4% All DTLs and DTAs must be reduced by this amount. Now, this is a typical schweser question that is pretty time intensive, because it wants you to calculate out the dtl/dta for each period first… that’s more than I’m going to do here and more than you need to do on any CFA question (no way is it a 90 second achievement)

Depreciation for Income statement: 25,352/5=5,065 Year 1: 25,352/5=5,065 Year 2: 25,352/5=5,065 Year 3: 25,352/5=5,065 Year 4: 25,352/5=5,065 Year 5: 25,352/5=5,065 Depreciation for tax report: Year 1: 25,352*.35=8,863.75 Year 2: 25,352*.35=8,863.75 Year 3: 25,352*.3=7,624.5 Year 4:0 Year 5:0 Year 1 builds a difference of 8,863.75-5,065=3,798.75, difference that builds a DTL of: 0.41*3,798.75=1,553.8 Year 2 builds a difference of 8,863.75-5,065=3,798.75, difference that builds a DTL of: 0.41*3,798.75=1,553.8 adding to the previous year DTL, for a total of 3,107.6 Year 3 builds a difference of 7,624.5-5,065=2,559.5, difference that builds a DTL of: 0.41*2,559.5=1,049.4 adding to the previous year DTL, for a total of 4,157.2 At change in taxes, the new DTL would be 4,157.2*0.31/0.41=3,143.2~3,144 The NI for the second problem is adjusted by the aftertax difference in DTL as result of tax changing: 4,157.2-3,144=1,013.2~1,014

exactly what I said :-)))

hmmm what kind of accelerated depreciation is that? i only know declining balance that looks remotely similar…

some sort of MACRS, SOYD is just a bit lower.

If you want to tackle these type of qustns quickly you can use the following approach: NBV (net book value) at end of 3rd year = 25,352 - 25,352/5*3 = 10,141 Tax basis at end of year = 25352 - 25352*(0.35+0.35+0.30) = 0 Excess NBV over tax basis = 10,141 - 0 = 10,141 (implies tax deprn was higher than book deprn so you have DTL) DTL at end of yr 3 (assuming no change in tax rate) = 10,141*0.41 = 4,158 DTL at end of yr 3 (assuming tax rate changes to 0.31) = 10,141*0.31 = 3,144 (answer to first qustn) Adjmnt requd in yr 3 for change in tax rate = 4,158 - 3,144 = 1,014 This the balance sheet approach of computing def taxes. Use this if you are dealing with qustns which require you to compute def taxes after a couple of years from start of the period when asset was purchased.