Hi from Schweser Proquestion: Kruger Associates uses an accrual basis for financial reporting purposes and cash basis for tax purposes. Cash collections from customers are $476,000, and accrued revenue is only $376,000. Assume expenses at 50% in both cases (i.e., $238,000 on cash basis and $188,000 on accrual basis), and a tax rate of 34%. What is the deferred tax asset or liability? A deferred tax: A) asset of $48,960. B) asset of $17,000. C) liability of $17,000. Your answer: C was incorrect. The correct answer was B) asset of $17,000. Since taxable income ($238,000) exceeds pretax income ($188,000), Kruger will have a deferred tax asset of $17,000 [($238,000 − $188,000)(0.34)]. but my idea is that: applying the accrual basis in financial statements means that combing both of cash basis and accural basis. what i want to say is that cash basis is something which is inside the accrual ( the accrual basis contain cash basis and figures ), but cash basis does not includ the accrual basis. so in this case in this example the company annuncing the total figure of 476000+376000 as revenue in income statement with the cost of 238000+188000, and the revenue of only 476000 in tax return and the cost of 238000+188000. (in accrual accounting the costs and expenses are considered costs both in cash and accrual event) The bottom line is taxable income (50000) and pretax income (426000), Kruger will have a deferred tax liability of $127840 [($426000 − $50,000)(0.34)]. I like to know if my interpretation on this question is right or not?
your interpretation is wrong. In the tax basis - company’s revenue is 376, expenses are 188 so taxable = 188 in the financial statements which includes accruals - revenues = 476, expenses = 238 so taxable basis = 238. essentially this difference would create an asset (prepaid revenues or sth like that) which would cause a DTA of 50*.34 = 17000 Company does not want to report as much tax on the tax statement to the govt. so they are reducing revenues and expenses to accomplish that. in no case would you end up summing both revenues and expenses like you have done.
Another way to look at this is that using a cash basis for taxes and an accrual basis for accounting purposes, their actual taxes paid are greater than tax expense calculated based on the financial statements. Therefore your taxes payable (tax expense + tax paid) is greater than tax expense resulting in a deferred tax asset.
Thanks CP for the clarification of the question