[Anonymous]

Quinn Co. reported a net deferred tax asset of $9,000 in its December 31, Year 1, balance sheet. For Year 2, Quinn reported pretax financial statement income of $300,000. Temporary differences of $100,000 resulted in taxable income of $200,000 for Year 2. At December 31, Year 2, Quinn had cumulative taxable differences of $70,000. Quinn’s effective income tax rate is 30%. In its December 31, Year 2, income statement, what should Quinn report as deferred income tax expense?

a. $12,000

b. $30,000

c. $60,000

d. $21,000

Explanation:

Choice “b” is correct, $30,000. Deferred tax expense is equal to the current period temporary differences times the enacted future tax rate: $100,000 × 30% = $30,000.

Analysis of deferred tax account:

12/31/Year 1 Change 12/31/Year 2

Temporary Differences $30 (100) (70)

Tax rate x 30% x 30%

Deferred tax asset 9 (9) 0

Deferred tax liability 0 (21) (21)

Net deferred tax 9 (30) (21)

So my question is why don’t you do anything with the $9,000? Isn’t that included in the DTA?

[rshukla]

As of 12/31/Y1, Quinn had a deferred tax asset of $9,000 (because tax return income was higher than F/S income). As of 12/31/Y2, Quinn had a deferred tax liability of $30,000 (because tax return income is lower than F/S income).

DTA from Y1 has not reversed as of 12/31/Y2 (see last two paragraphs). Therefore, as of 12/31/Y2 Quinn had a NET deferred tax liability of $21,000 (calculated as: $30,000 – $9,000). The $9,000 DTA is used to calculate your NET deferred tax position and not your deferred tax expense for Y2 which equals:

Y2 temporary differences (between F/S income and tax return income) X enacted tax rate

$100,000 x 30% = $30,000 deferred tax expense for Y2

The question mentioned cumulative temporary differences of $70,000 as of 12/31/Y2. This is correct because to have a deferred tax ASSET of $9,000 in Y1 at a tax rate of 30%, you need to have temporary differences of $30,000 in Y1 ($9,000 / 0.30 = $9,000). In other words, your taxable income was HIGHER from your financial statement income by $30,000 in Y1. You paid more taxes in Y1 which will be deductible on future tax returns (reducing future tax liability) and are therefore, deferred tax assets.

Similarly, to have a deferred tax LIABILITY of $30,000 in Y2 at a tax rate of 30%, you need to have temporary differences of $100,000 in Y2 ($30,000 / 0.30 = $100,000). In other words, your taxable income was LOWER from your financial statement income by $100,000 in Y2. You are paying less taxes in Y2 which will be paid on future tax returns (increasing future tax liability) and are therefore, deferred tax liabilities.

And obviously, $100,000 – $30,000 = $70,000 cumulative temporary differences as of 12/31/Y2.

AUD: 80's (Passed)
FAR: 80's (Passed)
BEC: 80's (Passed)
REG: 70's (Passed)

[Author]

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