hi all,
this is part of a Schweser question - The firm has recognized a bad debt expense of $10,000 in its financial statements which is not yet deductible for tax purposes. The bad debt expense created a DTA of $4,000 [($10,000 tax base − zero carrying value) × 40%].
why would the bad debt expense have a tax base = 10,000 and carrying value = 0… i thought it would similar treatment to a warranty, that has a zero tax base?
many thanks in advance
Because you cannot deduct the bad debt expense for tax purposes until you’ve established that the debt is uncollectable.
Because you have deducted the bad debt expense for financial accounting purposes.
hey thank you… im still so confused.
from the Schweser notes…
“The carrying value of the warranty liability is $5,000. The tax base is equal to the carrying value minus the amount deductible in the future. Thus, the warranty liability has a tax base of zero ($5,000 carrying value – $5,000 warranty expense deductible in the future). Delayed recognition of this expense for tax results in a deferred tax asset.”
they assign a carrying value of $5000 even though it is recognised on the Financials but not yet for tax purposes. then they assign a tax base of zero.
has it got to do with the fact that warranties are a liability and bad debt is a contra to the a/r under the current assets?
thanks again mate
Yes.
For an asset, the tax base is the amount that could be deducted in the future for tax purposes. For a liability, the tax base is the amount of the liability less the amount that could be deducted in the future for tax purposes. Allowance for Doubtful Accounts (the balance sheet account that corresponds to the income statement’s Bad Debt Expense) is, as you say, a contra-asset account, not a liability account.
thank you - the light-bulb just went on!!
cheers
My pleasure.