For the year 2004, SEH reported pretax financial income of $800,000 and taxable income of $440,000. The difference, which was the result of using the installment method of revenue recognition for tax purposes and the accrual method for financial reporting purposes, will reverse $120,000 in 2005, $60,000 in both 2006 and 2007, and $120,000 in 2008. The income tax rate was 35% for 2004. During 2005, Congress lowered the tax rate to 30% beginning Jan 1, 2006 and beginning Jan. 1, 2008, the tax rate will be 25%. Assuming positive earnings but no new temporary differences, calculate the balance of SEH’s deferred tax account at the end of 2005 and determine whether the balance is an asset or a liability. Balance; Deferred tax A. $66,000; Liability B. $66,000; Asset C. $102,000; Liability D. $102,000; Asset I am very impressed by how confusing the DTL questions can be, and by the fact that the right answer can easily be reached without knowing why. Can anybody explain this one?

I am going to take a guess on this one… Given Pretax income > Taxable income – it is a DTL. Original DTL = (800-440)*.35 = 126K In 2005 tax rate goes down from 35% to 30% since they are saying 120K will reverse in 2005 – that would translate to 120/.35 * .3 = 102857 So Choice C

As the Taxable income (TR side) is lower than Pretax income (FR side), it’s going to create a DTL. 120*0.30 + 60*0.30 + 60*0.30 + 120*0.25 = 102 C? - Dinesh S

Is it A? At the end of 2005: you have 60 K (2006) + 60vK(2007) @ 35% 120 K (2008) @ .25 DTA = 120 * .35 + 120 * .25 = 66000

Answer is A. The thing I don’t understand here is why we should add the future DTL to the second year DT balance?

I wrongly solved it above… solution is very similar to what sv102307 has above… only he should have said liability instead of asset. When you look at the end of 2005, you have three DTLs waiting to reverse 1. 60K in each of 2006 and 2007 (with a future tax rate of 35%) and 2. 120K in 2008 with a future tax rate of 25% so total DTL 120 ( .30 ) + 120 (.25) = 36 + 30 = 66K Since the Financial Pretax income > Tax Statement Taxable Income, you have a LIABILITY. HTH CP

SEH pretax financial income - $800,000 SEH taxable income - $440,000 Difference - 800-440 = 360k Since this is end of 2005, reduce 360k (original) by the 120k paid in 2005. Difference = 60k for 2006, 60k for 2007, 120 k for 2008. Tax rate for 2006 and 2007 is 30%, tax rate for 2008 is 25%. Balance for DTL at 2005 end is (60,000 * 30%) + (60,000 * 30%) + (120,000 * 25%) = $18k + $18k + $30k = $66k. Therefore, answer is A.

should we always do that? See this one: GHJ purchased a heavy-duty industrial steel press machine for $12,000. For book accounting purposes, GHJ will depreciate the new machine on a SL basis over 4 years with no salvage value. For tax accounting purposes, the company will depreciate the machine on a SL basis for 3 years with no salvage value. GHL’s current tax rate is 40%. however, Congress passed tax legislation which will reduce GHL’s taxes to 35% effective the second year. Revenue for the company is equal to $10,000 and there are no other expenses. What is GHJ’s deferred tax liability at the end of the first year, and will the second yare’s deferred tax liablity be the same or lower? First year deferred tax; second year deferred tax A. $2,400; Same B. $2,400; lower C. $400; same D. $400; lower In this question, why don’t we add the future changes in DT to the first year DT balance? So in anticipation of future tax cut, the first year DTL should be lower?

It is not the first year DTL that is lower. It is the future DTL (still on the books as an accounting entity) that would be lower. First year it will be at 40% so DTL = (12/3 - 12/4) * .4 = 1000 * .4 = 400 In the 2nd year the DTL of the first year will reduce to 350 and the 2nd year will have another DTL of 350 so cumulative DTL would become 700 for the 2nd year. Hope I have been able to explain that right.

I think it basically depends on when the tax chanegs were passed. As per the CFAI books if the tax Rate change was passed before the fin stmts were prepared, you would calculated the DTL/DTA based on the Tax Rates that are going to be applicable in the following year. However, if the tax changes are passed after the stmts are prepared, you would a. Use the current tax rates the current year b. Pass adjusting entries to the Deferred taxes & income taxes the subsequent year. So. End of year 1 (assuming tax rate chaneg is passed after the stmts are prepared): Deferred tax = 1000 * .40 = 400 End of eyar 2: pass adjusting entry for 50$ agaisnt previous eyars deferred taxes Calculate this years deferred tax = .35 *1000 = 350 Cumulative deferred = 700.