To download more slides, ebook, solutions and test bank, visit

CHAPTER 16
QUESTIONS
tax purposes now with corresponding high
deductions in future years. An example is
the difference between reporting an estimate of future warranty costs as an expense in the year of the sale for financial
reporting and waiting to record the deduction for tax purposes until the actual warranty costs are paid. A deductible temporary difference can also stem from reporting
high revenue for tax purposes now, with
corresponding low taxable revenue in future years. An example is the difference between reporting the receipt of advance rent
payments as revenue for tax purposes
when they are received and waiting to report the revenue until it is earned for financial reporting purposes.

1. Income measurement for financial reporting
purposes is designed to measure as fairly
as possible the increase in equity arising
from operations during the period. Income
measurement for tax purposes is selected
by the company to minimize its income tax
liability and by the government to raise revenue and to meet changing economic and
policy objectives. These different objectives
frequently result in different accounting methods for financial reporting and for income
tax purposes.
2. Certain expenses will never be deductible
for tax purposes because of provisions within the tax law. These are referred to as permanent differences or nondeductible expenses. Temporary differences are differences between taxable and financial income
that result in taxable or deductible amounts
when the reported amount of an asset or a
liability in the financial statements is recovered or settled, respectively. A temporary
difference that results in a larger currentyear taxable income will reverse in a future
year and result in a deductible amount to
offset against other taxable income. While a

nondeductible expense is never deductible
for tax purposes, a temporary difference is
deductible in future periods.

4. The no-deferral approach is simple, but it
violates a fundamental precept of accrual
accounting: Reported expenses should reflect all current and future outflows resulting
from a transaction. The no-deferral approach ignores the fact that transactions in
one period often have foreseeable tax consequences in future periods.
5. The major advantages of the asset and liability method are that the assets and liabilities recorded under this method match
the conceptual definitions for these elements and that the method allows for recognition of changes in circumstances and
changes in enacted tax rates.

3. A taxable temporary difference is one that will
result in taxable amounts in future years.
Taxable temporary differences involve reporting high deductions for tax purposes now with
corresponding low deductions in future years.
An example is the difference between
straight-line depreciation for financial reporting purposes and MACRS for tax purposes.
A taxable temporary difference can also
stem from reporting low revenue for tax
purposes now with corresponding high taxable revenue in future years. An example is
the difference between the installment
sales method for tax purposes and the accrual method for financial reporting.

6. One drawback of the asset and liability method is that in some ways it is too complicated. Many financial statement users
claim that they ignore deferred tax assets
and liabilities anyway; thus, efforts devoted
to deferred tax accounting are just a waste
of time.

7. When rate changes are enacted after a deferred tax liability or asset has been recorded, the beginning deferred tax account
is adjusted to reflect the new enacted rates.
The income effect of the change is shown
as either an addition to or a subtraction
from income tax expense for the period.

A deductible temporary difference is one
that will result in deductible amounts in future years. Deductible temporary differences involve reporting low deductions for

721


To download more slides, ebook, solutions and test bank, visit
722

8. A valuation allowance is necessary when
available evidence indicates that it is more
likely than not that some portion or all of the
benefit of a deferred tax asset will not be
realized.
9. The Board indicates that “more likely than
not” means a level of likelihood that is at
least more than 50%. The FASB did not establish specific criteria for evaluating more
likely than not but did suggest that if a
company has a history of operating losses,
has had tax carryforwards expire unused,
or has prospective future losses even if the
company has been profitable in the past, it
may be more likely than not that the benefit
of deferred tax assets may not be realized.

10. Some possible sources of income through
which the tax benefit of a deferred tax asset
can be realized are as follows:
(a) Future reversals of existing taxable
temporary differences
(b) Future taxable income
(c) Taxable income in prior carryback
years
11. Current federal tax laws provide for an
optional 2-year carryback and a 20-year
carryforward of net operating losses. If
the carryback provision is used, the earliest carryback year (second previous
year) is used first. If there is still unused
loss, it is carried forward to the immediately
succeeding year. Any remaining unused
portion of the loss is then forwarded to the
next year and so on until 20 years have
passed or until the loss is completely offset
against income, whichever comes first.
12. Deferred tax assets arising from NOL carryforwards are classified according to the expected time of their utilization. If the NOL
carryforward is expected to be used in the
coming year, the deferred tax asset is classified as current. Otherwise, it is classified
as noncurrent.
13. Topic 740 requires scheduling when differences in enacted future tax rates from one
year to the next make it necessary to schedule the timing of a reversal in order to
match the reversal with the tax rate expected to be in effect in the year in which it
occurs.
14. An uncertain tax position is a tax position
taken by a taxpayer where there is a


Chapter 16

greater than 50% chance that the position
taken will be sustained yet there is significant uncertainty about the amount that will
be sustained. If there is a greater than 50%
chance that the position will be sustained
and a greater than 50% chance that the full
amount in question will be allowed, this situation is termed a “highly certain” tax position.
15. Step 1 is to determine if it is more likely
than not that a tax position would be sustained if it were to be examined. If it is more
likely than not that the position will be sustained, then step 2 is to measure the tax
benefit based on probability assessments.
The amount of benefits is measured by taking the largest amount of tax benefit that is
greater than 50% likely of being realized
upon settlement.
16. Disagree. Accounting for uncertain tax positions requires the exercise of a substantial amount of judgment. Both the accountant and, probably, a tax expert must exercise professional judgment in evaluating
the likelihood of an uncertain tax position
being upheld.
17. Prior to pre-Codification Statement No.
109, income tax carryforwards could be
recognized only if future income was assured beyond reasonable doubt. If preCodification Statement No. 96 had been
implemented, income tax carryforwards
would never have been recognized. However, under FASB Statement No. 109, income tax carryforwards can be recognized
unless it is more likely than not that future
income will not be sufficient to realize a
benefit from the carryforward. Note: PreCodification Statement No. 109 is the
source for most of the existing provisions in
FASB ASC Topic 740.
18. Changes in the amount of deferred tax assets and liabilities do not require or provide
cash. However, they do affect the amount

of income tax expense that is deducted in
arriving at net income. Therefore, a statement of cash flows must adjust for this fact.
Under the indirect method, changes in the
deferred balances are reported as adjustments to net income in arriving at cash flow
from operations. Under the direct method,
the actual income tax payments or refunds
would be reported rather than the amount
reported as income tax expense or benefit.


To download more slides, ebook, solutions and test bank, visit
Chapter 16

19. Income tax carrybacks and carryforwards
reduce the amount reported as an operating loss for the current period. However,
they do not provide cash flows until carryback refunds are received or future tax
payments are reduced due to the existence
of the carryforward. The statement of cash
flows must show these carrybacks and carryforwards as adjustments to cash flow
from operations.
20. Current deferred tax assets and current
deferred tax liabilities are netted against
one another and reported as a single
amount. Also, noncurrent deferred tax assets and liabilities are netted and reported
as a single amount.
21. In the past, in many foreign countries generally accepted accounting standards were
based on the income tax laws of the country. Thus, in these countries very few, if

723


any, temporary differences existed between reported income and taxable income. With the widespread adoption of
IFRS, this is no longer true.
22. In 1996, the IASB revised IAS 12; the accounting required in the revised version is
very similar to the deferred tax accounting
practices used in the United States.
23. The partial recognition approach results in
a deferred tax liability being recorded only
to the extent that the deferred taxes are actually expected to be paid in the future. The
reasoning behind the partial recognition
approach is that if a liability is deferred indefinitely, the present value of that liability
is zero. Despite its conceptual attractiveness, the partial recognition approach is on
the verge of being dropped in the United
Kingdom in the interest of international
harmonization.


To download more slides, ebook, solutions and test bank, visit
Chapter 16

724

PRACTICE EXERCISES
PRACTICE 16–1 SIMPLE DEFERRED TAX LIABILITY
Income statement
Sales ..............................................................................................
Income tax expense:
Current ($70,000 × 0.35).......................................................
Deferred ($30,000 × 0.35) .....................................................
Total income tax expense ...................................................
Net income ....................................................................................


$100,000
$24,500
10,500
(35,000)
$ 65,000

Income Tax Expense............................................................
Income Tax Payable .......................................................
Deferred Tax Liability .....................................................

35,000
24,500
10,500

PRACTICE 16–2 SIMPLE DEFERRED TAX ASSET
Income statement
Sales ..............................................................................................
Expenses .......................................................................................
Bad debt expense .........................................................................
Income before income taxes .......................................................
Income tax expense:
Current ($42,000 × 0.30).......................................................
Deferred benefit ($12,000 × 0.30) ........................................
Total income tax expense ...................................................
Net income ....................................................................................

$ 200,000
(158,000)
(12,000)

$ 30,000
$ (12,600)
3,600
(9,000)
$ 21,000

Income Tax Expense............................................................
Deferred Tax Asset ..............................................................
Income Tax Payable .......................................................

9,000
3,600
12,600

PRACTICE 16–3 PERMANENT AND TEMPORARY DIFFERENCES
Pretax financial income ...............................................................
Add (deduct) permanent differences:
Nontaxable interest revenue on municipal bonds............
Nondeductible expenses.....................................................
Financial income subject to tax ..................................................
Add temporary difference on warranty expenses.....................
Taxable income.............................................................................
1.
2.
3.
4.

Financial income subject to tax = $57,000
Taxable income = $65,000
Income tax expense = $57,000 × 0.30 = $17,100

Net income = $50,000 – $17,100 = $32,900

$50,000
$ (10,000)
17,000

7,000
$57,000
8,000
$65,000


To download more slides, ebook, solutions and test bank, visit
Chapter 16

725

PRACTICE 16–4 DEFERRED TAX LIABILITY
Income Tax Expense............................................................
Income Tax Payable .......................................................
Deferred Tax Liability .....................................................

4,320
4,000
320

Income tax expense: ($10,000 + $800 unrealized gain) × 0.40 = $4,320
Income tax payable: $10,000 × 0.40 = $4,000
PRACTICE 16–5 DEFERRED TAX LIABILITY
Income statement for 2013:

Revenue.........................................................................................
Depreciation expense (straight line)...........................................
Income before income taxes .......................................................
Income tax expense:
Current [($50,000 – $25,000) × 0.40] ...................................
Deferred ($10,000 × 0.40) .....................................................
Total income tax expense ...................................................
Net income ....................................................................................

$ 50,000
15,000
$ 35,000
$10,000
4,000
14,000
$ 21,000

2013
Income Tax Expense............................................................
Income Tax Payable .......................................................
Deferred Tax Liability .....................................................

14,000

Income Tax Expense............................................................
Income Tax Payable .......................................................
Deferred Tax Liability .....................................................

14,000


10,000
4,000

2014
12,000
2,000

Income tax payable: ($50,000 – $20,000) × 0.40 = $12,000
2015
Income Tax Expense............................................................
Income Tax Payable .......................................................

14,000
14,000

Income tax payable: ($50,000 – $15,000) × 0.40 = $14,000
2016
Income Tax Expense............................................................
Deferred Tax Liability...........................................................
Income Tax Payable .......................................................

14,000
2,000
16,000

Income tax payable: ($50,000 – $10,000) × 0.40 = $16,000
2017
Income Tax Expense............................................................
Deferred Tax Liability...........................................................
Income Tax Payable .......................................................

Income tax payable: ($50,000 – $5,000) × 0.40 = $18,000

14,000
4,000
18,000


To download more slides, ebook, solutions and test bank, visit
Chapter 16

726

PRACTICE 16–6 VARIABLE FUTURE TAX RATES
Income Tax Expense............................................................
Income Tax Payable .......................................................
Deferred Tax Liability .....................................................

4,368
4,000
368

Income tax expense:
Current
$10,000 × 0.40 = $4,000
Deferred $800 × 0.46 = $368
PRACTICE 16–7 CHANGE IN ENACTED TAX RATES
As of the beginning of 2015, the accumulated excess of tax depreciation over book
depreciation is $15,000 composed of a $10,000 ($25,000 – $15,000) excess in 2013
and a $5,000 ($20,000 – $15,000) excess in 2014. This means that the existing deferred tax liability is $6,000 ($15,000 × 0.40).
1.


Deferred Tax Liability...........................................................
Income Tax Benefit—Rate Change...............................

1,500
1,500

Change in deferred tax liability: $6,000 – ($15,000 × 0.30) = $1,500
2.

Income Tax Expense—Rate Change ..................................
Deferred Tax Liability .....................................................

450
450

Change in deferred tax liability: ($15,000 × 0.43) – $6,000 = $450
PRACTICE 16–8 DEFERRED TAX ASSET
Income Tax Expense............................................................
Deferred Tax Asset ..............................................................
Income Tax Payable .......................................................

1,845
405

Income tax expense: ($5,000 – $900 unrealized loss) × 0.45 = $1,845
Income tax payable: $5,000 × 0.45 = $2,250

2,250



To download more slides, ebook, solutions and test bank, visit
Chapter 16

727

PRACTICE 16–9 DEFERRED TAX ASSET
Income statement:
Revenue.........................................................................................
Postretirement health care expense...........................................
Bad debt expense .........................................................................
Income before income taxes .......................................................
Income tax expense:
Current [($60,000 – $2,000) × 0.41] .....................................
Deferred benefit [($8,000 + $15,000) × 0.41].......................
Total income tax expense ...................................................
Net income ....................................................................................
Income Tax Expense............................................................
Deferred Tax Asset ..............................................................
Income Tax Payable .......................................................

$ 60,000
(15,000)
(10,000)
$ 35,000
$23,780
(9,430)
14,350
$ 20,650
14,350

9,430
23,780

PRACTICE 16–10 DEFERRED TAX LIABILITIES AND ASSETS
Income statement:
Income before trading securities, restructuring,
and taxes...............................................................................
Unrealized gain on trading securities ($4,200 – $2,000) ...........
Restructuring charge (impairment write-down) ........................
Income before income taxes .......................................................
Income tax expense:
Current ($25,000 × 0.40).......................................................
Deferred expense ($2,200 × 0.40)........................................
Deferred benefit ($7,000 × 0.40) ..........................................
Total income tax expense ...................................................
Net income ....................................................................................
Income Tax Expense............................................................
Deferred Tax Asset ..............................................................
Deferred Tax Liability .....................................................
Income Tax Payable .......................................................

$ 25,000
2,200
(7,000)
$ 20,200
$ 10,000
880
(2,800)
8,080
$ 12,120

8,080
2,800
880
10,000

It must be assumed that future income will be sufficient to allow for the full utilization
of the $7,000 deduction from the decline in the value of the manufacturing facility.
The unrealized gain of $2,200 on the trading securities will provide a portion, but not
all, of the necessary future income.


To download more slides, ebook, solutions and test bank, visit
Chapter 16

728

PRACTICE 16–11 DEFERRED TAX LIABILITIES AND ASSETS
Income statement:
Income before trading securities, depreciation,
and taxes...............................................................................
Unrealized loss on trading securities ($1,000 – $700) ..............
Depreciation ($10,000/4 years) ....................................................
Income before income taxes .......................................................
Income tax expense:
Current [($4,000 − $3,300) × 0.40] .......................................
Deferred expense [($3,300 – $2,500) × 0.40] ......................
Deferred benefit ($300 × 0.40) .............................................
Total income tax expense ...................................................
Net income ....................................................................................
Income Tax Expense............................................................

Deferred Tax Asset ..............................................................
Deferred Tax Liability .....................................................
Income Tax Payable .......................................................

$ 4,000
(300)
(2,500)
$ 1,200
$ 280
320
(120)
$

480
720

480
120
320
280

The reversal of the temporary depreciation difference will create $800 of additional
taxable income in future years. This is a probable source of future taxable income
against which the $300 unrealized loss on the trading securities can be offset. So, in
this case there is already strong evidence, without additional assumptions, that there
will be sufficient future taxable income to allow for the full utilization of the unrealized loss.
PRACTICE 16–12 VALUATION ALLOWANCE
The amount of the $900 loss that can be used as a tax deduction in future years is
$400. Thus, even though a $405 ($900 × 0.45) deferred tax asset has been recognized,
only $180 ($400 × 0.45) of the future benefit will be realized. The necessary adjustment is as follows:

Income Tax Expense............................................................
Valuation Allowance ($405 – $180) ...............................

225
225

The net deferred tax asset is now $180 = $405 deferred tax asset – $225 valuation
allowance.


To download more slides, ebook, solutions and test bank, visit
Chapter 16

729

PRACTICE 16–13 VALUATION ALLOWANCE
The amount of the future $8,000 bad debt write-off and the future $15,000 retiree
health care expenditure that can be used as a tax deduction in future years is limited
to $20,000. Thus, even though a $9,430 ($23,000 × 0.41) deferred tax asset has been
recognized, only $8,200 ($20,000 × 0.41) of the future benefit will be realized. The necessary adjustment is as follows:
Income Tax Expense............................................................
Valuation Allowance ($9,430 – $8,200) .........................

1,230
1,230

The net deferred tax asset is now $8,200 = $9,430 deferred tax asset – $1,230 valuation allowance. More precise estimates of the timing of the future taxable income
would be needed to determine how the valuation allowance should be allocated
between the bad debt and the postretirement health care portions of the overall
deferred tax asset.

PRACTICE 16–14 UNCERTAIN TAX POSITION
A “highly certain” tax position requires at least a 50% likelihood that the position will
be sustained for the full amount of the position. An “uncertain” tax position requires
at least a 50% likelihood that the position will be sustained but a “less than 50%”
chance that the full amount will be sustained. For tax positions where there is a “less
than 50%” chance that the position will be sustained, as is the case here, a liability is
recognized in the amount of the tax benefit.
PRACTICE 16–15 UNCERTAIN TAX POSITION
A “highly certain” tax position requires at least a 50% likelihood that the position will
be sustained for the full amount of the position. Since this example satisfies these
conditions, the full amount would be recognized as a tax benefit in the current period
on the income statement.
PRACTICE 16–16 UNCERTAIN TAX POSITION
Because there is a greater than 50% chance that the company’s position will be sustained and because there is uncertainty regarding the amount that will be sustained,
this example qualifies as an “uncertain” tax position. The amount of the benefit is
computed by first determining the largest amount of tax benefit that is greater than
50% likely to be realized. In this instance, that amount is $40. The journal entry required to record the unrecognized tax benefit is as follows:
Income Tax Expense............................................................
Unrecognized Tax Benefit .............................................

60
60

This journal entry recognizes the difference between the actual reduction in taxes (or
tax benefit) on the income tax return ($100) filed this period and the expected amount
of benefit based on the uncertain tax position analysis ($40).


To download more slides, ebook, solutions and test bank, visit
Chapter 16


730

PRACTICE 16–17 NET OPERATING LOSS CARRYBACK
The $93,000 net operating loss is first carried back two years to recover the tax paid
on the $75,000 taxable income reported in 2011. The remaining $18,000 ($93,000 –
$75,000) NOL is carried back to 2012. The income tax refund is computed as follows:
NOL Carried
Back to
2011
2012
Total refund

Taxable
Income
$75,000
18,000

Income Tax
Rate
25%
30

Tax
Refund
$18,750
5,400
$24,150

Journal entry:

Income Tax Refund Receivable ....................................
Income Tax Benefit—NOL Carryback .....................

24,150
24,150

PRACTICE 16–18 NET OPERATING LOSS CARRYFORWARD
1.

The $150,000 net operating loss is first carried back two years to recover the tax
paid on the $75,000 taxable income reported in 2011. The remaining $75,000
($150,000 – $75,000) NOL is carried back to 2012. The income tax refund is
computed as follows:
NOL Carried
Back to
2011
2012
Total refund

Taxable
Income
$75,000
50,000

Income Tax
Rate
25%
30

Journal entry:

Income Tax Refund Receivable ....................................
Income Tax Benefit—NOL Carryback .....................

Tax
Refund
$18,750
15,000
$33,750
33,750
33,750

No assumption is necessary here; this is a straightforward request to the
government to refund cash paid for income taxes in prior years.
2.

The 2-year carryback used $125,000 ($75,000 + $50,000) of the net operating
loss, leaving $25,000 ($150,000 – $125,000) as an NOL carryforward. The future
benefit of the NOL carryforward in terms of future tax reductions is $8,750
($25,000 × 0.35). The journal entry to record the NOL carryforward is as follows:
Deferred Tax Asset—NOL Carryforward......................
Income Tax Benefit—NOL Carryforward ................

8,750
8,750

One must assume that it is more likely than not that future taxable income will
be sufficient, within the 20-year carryforward period, to allow the company to
utilize the $25,000 in NOL carryforwards.



To download more slides, ebook, solutions and test bank, visit
Chapter 16

731

PRACTICE 16–19 NET OPERATING LOSS CARRYFORWARD
Treatment of NOL in 2014:
NOL Carried
Back to
2012
2013
Total refund

Taxable
Income
$15,000
20,000

Income Tax
Rate
35%
35

Tax
Refund
$ 5,250
7,000
$12,250

The carryback period is just two years, so the NOL in 2014 cannot be carried back

against 2011 taxable income. The NOL carryforward remaining in 2014 is $65,000
($100,000 – $15,000 – $20,000).
In 2015, the $65,000 NOL carryforward will be offset against the $50,000 taxable income for the year. No income tax will be paid in 2015, and there will remain a $15,000
($65,000 – $50,000) NOL carryforward from 2014.
In 2016, there is no taxable income against which the $200,000 NOL can be carried
back; the $50,000 in taxable income in 2015 was offset against the NOL carryforward
from 2014. So, the entire $200,000 NOL from 2016 is carried forward. The NOL carryforward is worth $80,000 ($200,000 × 0.40) in future tax benefits. The appropriate
journal entry is as follows:
Deferred Tax Asset—NOL Carryforward ...........................
Income Tax Benefit—NOL Carryforward......................

80,000
80,000

Of course, one must assume that it is more likely than not that future taxable income
will be sufficient, within the 20-year carryforward period, to allow the company to
utilize the $215,000 in NOL carryforwards ($15,000 remaining from 2014 plus $200,000
from 2016). With the company’s rocky recent past, this may not be a reasonable
assumption.
PRACTICE 16–20 SCHEDULING FOR ENACTED FUTURE TAX RATES
The $10,000 taxable temporary difference created in 2013 will reverse partially in
2016, with the remainder reversing in 2017. As seen in the solution to Practice 16–5,
the pattern of the creation and reversal of this temporary difference is as follows:

2013
2014
2015
2016
2017


Temporary
Difference
Creation
(reversal)
$ 10,000
5,000
0
(5,000)
(10,000)


To download more slides, ebook, solutions and test bank, visit
Chapter 16

732

PRACTICE 16–20 (Concluded)
The income tax expected to be paid when the $10,000 temporary difference from 2013
reverses is computed as follows:

2016
2017

Temporary
Difference
Creation
(reversal)
$(5,000)
(5,000)


Tax Rate
37%
31

Additional
Income Tax
$1,850
1,550
$3,400

The necessary journal entry to record income tax expense in 2013 is as follows:
Income Tax Expense............................................................
Income Tax Payable .......................................................
Deferred Tax Liability .....................................................

13,400
10,000
3,400

PRACTICE 16–21 REPORTING DEFERRED TAX ASSETS AND LIABILITIES
1.

The $120 deferred tax asset is related to a current item (trading securities). The
$320 deferred tax liability is related to a noncurrent item (equipment). Accordingly, the deferred tax asset and liability should not be netted against one
another for reporting purposes. In the balance sheet, the company would report a current deferred tax asset of $120 and a noncurrent deferred tax liability
of $320.

2.

Deferred tax asset:

Unrealized loss on trading securities...........................

$120

Deferred tax liability:
Depreciation....................................................................

$320

PRACTICE 16–22 COMPUTATION OF EFFECTIVE TAX RATE
Effective tax rate = Income tax expense/Pretax financial income
= $17,100/$50,000
= 34.2%


To download more slides, ebook, solutions and test bank, visit
Chapter 16

733

PRACTICE 16–23 RECONCILIATION OF STATUTORY RATE AND EFFECTIVE RATE
Sales ...........................................................................................
Add: Interest revenue from municipal bonds.......................

$ 60,000
7,000
$ 67,000

Deduct:
Depreciation expense ....................................................

Expenses not deductible for tax purposes..................
Warranty expenses ........................................................
Pretax financial income ............................................................

$25,000
18,000
10,000

Add (deduct) permanent differences:
Nontaxable interest revenue on municipal bonds ......
Nondeductible expenses ...............................................
Financial income subject to tax ...............................................

$ (7,000)
18,000

Add temporary difference on warranty expenses..................
Deduct temporary difference for excess depreciation ..........
Taxable income..........................................................................
1.

Effective tax rate =
=
=
=

$ 8,000
(11,000)

Income tax expense/Pretax financial income

($25,000 × 0.35)/$14,000
$8,750/$14,000
62.5%

2.
Pretax financial income......................
Income tax at statutory rate of 35.0%
Nontaxable interest revenue..............
Nondeductible expenses....................
Income tax expense............................

Amount
$14,000
$ 4,900
(2,450)
6,300
$ 8,750

Rate
35.0%
(17.5%)
45.0%
62.5%

PRACTICE 16–24 DEFERRED TAXES AND OPERATING CASH FLOW
Net income .................................................................................
Plus: Depreciation .....................................................................
Less: Increase in accounts receivable ....................................
Plus: Decrease in inventory .....................................................
Less: Decrease in accounts payable.......................................

Plus: Increase in income taxes payable..................................
Plus: Increase in deferred tax liability .....................................
Cash flow from operating activities.........................................

$10,000
2,000
(1,200)
850
(300)
40
1,430
$12,820

53,000
$ 14,000

11,000
$ 25,000
(3,000)
$ 22,000


To download more slides, ebook, solutions and test bank, visit
Chapter 16

734

PRACTICE 16–25 CASH PAID FOR INCOME TAXES
Compute the current portion of income tax expense. The deferred portion does not
need to be paid.

Total income tax expense ................................................
Less: Deferred tax expense ($130,000 – $90,000)..........
Current income tax expense ......................................

$60,000
40,000
$20,000

Compute how much of the current expense was paid in cash this year.
Beginning balance in income taxes payable..................
Plus: Current year’s tax bill..............................................
Total payable................................................................
Less: Ending balance in income taxes payable.............
Cash paid for income taxes........................................

$22,000
20,000
$42,000
17,000
$25,000


To download more slides, ebook, solutions and test bank, visit
Chapter 16

735

EXERCISES
16–26.


Type of Difference
(a) Temporary
(b) Temporary
(c) Nondeductible
(d) Temporary
(e) Temporary
(f) Nontaxable

Deferred Tax Asset
or Liability
Deferred tax liability
Deferred tax liability
Not applicable
Deferred tax asset
Deferred tax asset
Not applicable

16–27.
Pretax financial income ................................................................
Permanent differences:
Add: Life insurance premium...................................................
Less: Municipal bond interest..................................................
Pretax financial income subject to tax ........................................
Timing differences:
Add: Rent collected in advance of period earned .................
Warranty provision in excess of payments
made.............................................................................
Less: Tax depreciation in excess of book
depreciation .................................................................
Installment sales income on books in excess

of taxable income ........................................................
Taxable income..............................................................................

$ 2,900,000
$ 95,000
30,000

65,000
$ 2,965,000

$ 75,000
40,000

115,000
$ 3,080,000

$150,000
130,000

280,000
$ 2,800,000

16–28.
1.

Income Tax Expense.............................................................
Income Taxes Payable ....................................................
Deferred Tax Liability—Current .....................................

124,250

112,000
12,250

Income tax expense: Current (0.35 × $320,000) + Deferred
(0.35 × $35,000) = $124,250
2.

Income Tax Expense (0.35 × $35,000)*................................
Deferred Tax Liability—Current .....................................
*Alternate computation:
$70,000 × 0.35 = $24,500; $24,500 – $12,250 = $12,250

12,250
12,250


To download more slides, ebook, solutions and test bank, visit
Chapter 16

736

16–29.
1.

2.

Current asset section:
Deferred tax asset....................................
Noncurrent asset section:
Deferred tax asset....................................

*($120,000 × 0.20) × 0.40 = $9,600
†
($120,000 × 0.80) × 0.40 = $38,400
Current asset section:
Deferred tax asset....................................
Less: Valuation allowance......................
Noncurrent asset section:
Deferred tax asset....................................
Less: Valuation allowance......................

$ 9,600*
$ 38,400†

$ 9,600
(2,880)*
$ 6,720
$ 38,400
(11,520)†
$ 26,880

COMPUTATIONS:
Total valuation allowance:
$48,000 – ($48,000 × 0.70) = $14,400
*$14,400 × 0.20 = $2,880
†
$14,400 × 0.80 = $11,520
16–30.
1.

Deferred Tax Asset—Current ........................................................

Income Taxes Payable .............................................................
Income Tax Benefit...................................................................

10,000
2,800
7,200

Income taxes payable: Pretax financial loss of $18,000 + $25,000 rent revenue
recognized for tax purposes = $7,000 taxable income; $7,000 × 0.40 = $2,800
Income tax benefit: Current expense (0.40 × $7,000) – Deferred benefit (0.40 ×
$25,000) = $7,200
2.

One source of taxable income through which the benefit of the deferred tax
asset can be realized is through the NOL carryback provision in the income
tax laws. If Fulton has tax losses in the next two years, they may be carried
back against the $7,000 in 2013 taxable income. Another source of potential
taxable income is income from the sale of appreciated assets. Topic 740 stipulates that both positive and negative evidence be considered when determining whether deferred tax assets will be fully realized and thus whether a valuation allowance is necessary. Examples of negative evidence include unsettled
circumstances that might cause a company to report losses in future years.


To download more slides, ebook, solutions and test bank, visit
Chapter 16

737

16–31.
1.

Deferred Tax Asset—Current (0.35 × $42,000) ............................

Income Taxes Payable .............................................................
Income Tax Benefit...................................................................

14,700
9,450
5,250

Income tax benefit: Current expense (0.35 × $27,000) – Deferred benefit (0.35 ×
$42,000) = $5,250
2.

If future taxable income is zero, the only source of taxable income through
which the benefit of the deferred tax asset can be realized is the $27,000
taxable income for 2013 via the carryback provisions. Thus, the deferred tax
asset must be reduced by a valuation allowance for the tax effect of the
$15,000 ($42,000 – $27,000) in tax benefits that are unlikely to be realized. The
following entry would be added to those already given in (1):
Income Tax Benefit (0.35 × $15,000).............................................
Allowance to Reduce Deferred Tax Asset to
Realizable Value—Current ....................................................

5,250

Income Tax Expense......................................................................
Income Taxes Payable .............................................................
Deferred Tax Liability—Noncurrent ........................................

20,000

5,250


16–32.
1.

6,000
14,000

Income tax expense: Current (0.40 × $15,000) + Deferred [(0.40 × $155,000) –
$48,000] = $20,000
2.

Deferred Tax Liability—Noncurrent..............................................
Income Tax Benefit—Rate Change .........................................
[(0.40 × $155,000) – (0.32 × $155,000);
or (0.40 – 0.32) × $155,000]

12,400
12,400

16–33.
Income Tax Expense...................................................................... 215,600
Income Taxes Payable .............................................................
187,600*
Deferred Tax Liability—Noncurrent ........................................
28,000
Income tax expense: Current ($187,600) + Deferred (0.40 × $70,000) = $215,600
*Pretax financial income....................................................
Less: Interest revenue (permanent difference)..............
Pretax financial income subject to income tax..............
Deduct: Excess of tax depreciation over book

depreciation ($650,000 – $580,000).............................
Taxable income .................................................................
Income tax rate..................................................................
Income taxes payable...................................................

$ 637,000
98,000
$ 539,000
70,000
$ 469,000
×
0.40
$ 187,600


To download more slides, ebook, solutions and test bank, visit
Chapter 16

738

16–34.
Income Tax Expense......................................................................
Income Taxes Payable .............................................................
[($35,000 + $55,000) × 0.34]

30,600

Deferred Tax Asset—Current ........................................................
Deferred Tax Asset—Noncurrent .................................................
Income Tax Benefit...................................................................


5,100
12,560

30,600

17,660

The income tax benefit account offsets the income tax expense account.
Enacted
Rate
34%
30
30
37

2014
2015
2016
2017

Deductible
Amount
$15,000
20,000
12,000
8,000
$55,000

Asset

Valuation
$ 5,100
6,000
3,600
2,960
$17,660

Because the unearned rent revenue account under these conditions would be
reported as part current and part noncurrent, the deferred tax asset would be
classified in the same pattern. The current deferred taxes balance would be
$5,100 and the noncurrent is $12,560 ($17,660 – $5,100).
Because it is assumed that in each year from 2014–2017 there is sufficient income to equal the temporary difference reversal, the carryback and carryforward rules would not be needed, and the tax rate applied to each reversal
would be the marginal tax rate for each year.
16–35.
Income Tax Expense......................................................................
Income Taxes Payable .............................................................
[($40,000 + $25,000 – $22,000 + $18,000) × 0.40]

24,400

Deferred Tax Asset—Current ........................................................
Income Tax Expense......................................................................
Deferred Tax Liability—Current ..............................................
Deferred Tax Liability—Noncurrent ........................................

5,940
1,170

2014
2015

2016
2017

Enacted
Rate
35%
32
30
32

Deductible
Amount
$ 6,000
12,000
—
—
$18,000

Asset
Valuation
$2,100
3,840
—
—
$5,940

Taxable
Amount
$ 5,000
7,000

4,000
6,000
$22,000

24,400

1,750
5,360
Liability
Valuation
$1,750
2,240
1,200
1,920
$7,110


To download more slides, ebook, solutions and test bank, visit
Chapter 16

739

16–35. (Concluded)
Current items:
Deferred tax asset...................................................
(underlying asset is current)
Deferred tax liability................................................
Net deferred tax asset ............................................

1,750

$4,190

Noncurrent items:
Deferred tax liability ($7,110 – $1,750) ..................

$5,360

$5,940

16–36.
Income Tax Expense .................................................................. 319,200
Income Taxes Payable ...........................................................
319,200
($912,000 × 0.35)
Deferred Tax Asset—Current ....................................................
Income Tax Expense. .................................................................
Deferred Tax Liability—Current.............................................
Deferred Tax Liability—Noncurrent ......................................
COMPUTATIONS:
Current items:
Deferred tax liability ($315,000 × 0.35)..............
(underlying asset is current)
Deferred tax asset ($180,000 × 0.35) .................
(underlying liability is current)
Net deferred tax liability .....................................
Noncurrent items:
Deferred tax liability ($95,000 × 0.35) ................
(underlying asset is noncurrent)

63,000

80,500
110,250
33,250

$110,250
63,000
$ 47,250
$ 33,250

(Note: In connection with the deferred tax asset, no assumption about
future income is necessary because the taxable temporary differences are
sufficient to allow for complete recognition of the deferred tax asset.)
16–37.
1.

Income Tax Expense ................................................................
Income Taxes Payable........................................................
($50,000 × 0.40)

20,000

Deferred Tax Asset—Noncurrent............................................
Income Tax Benefit .............................................................

16,290

20,000

16,290


The income tax benefit account offsets the income tax expense account.


To download more slides, ebook, solutions and test bank, visit
Chapter 16

740

16–37. (Concluded)

2014
2015
2016

2.

Enacted
Rate
38%
35
36

Deductible
Amount
$ 12,000
15,000
18,000
$ 45,000

Asset

Valuation
$ 4,560
5,250
6,480
$16,290

If taxable income in future periods is more likely than not to be zero and in
the absence of taxable temporary differences, the one source of taxable
income through which to recognize the tax benefit of the deductible
amounts is by carrying them back and applying them against 2013 taxable
income. Deductible amounts totaling $27,000 can be carried back, yielding
a tax benefit of $10,800 ($27,000 × 0.40). The carryback amount is restricted
to $27,000 ($12,000 + $15,000) because losses can be carried back only two
years. Note that because the tax benefit is realized through carryback to
2013, the 2013 tax rate is used to compute the amount of the tax benefit. A
valuation allowance is needed to reduce the deferred tax asset to its realizable amount. The following journal entry would be added to those given in
(1):
Income Tax Benefit...................................................................
Allowance to Reduce Deferred Tax
Asset to Realizable Value—Noncurrent ..........................
($16,290 – $10,800)

5,490

Income Tax Expense ................................................................
Income Taxes Payable........................................................
($75,000 × 0.40)

30,000


Deferred Tax Asset—Noncurrent............................................
Income Tax Benefit .............................................................

30,180

5,490

16–38.
1.

30,000

30,180

The income tax benefit account offsets the income tax expense account.

2014
2015
2016
2017

Enacted
Rate
35%
32
30
32

Deductible
Amount

$14,000
24,000
16,000
40,000
$94,000

Asset
Valuation
$ 4,900
7,680
4,800
12,800
$30,180


To download more slides, ebook, solutions and test bank, visit
Chapter 16

741

16–38. (Concluded)
2.

If taxable income in future periods is more likely than not to be zero, and in
the absence of taxable temporary differences, the one source of taxable income through which to recognize the tax benefit of the deductible amounts
is by carrying them back and applying them against 2013 taxable income.
However, recall that the tax code allows carryback for only two years.
Accordingly, the $40,000 deductible amount in 2017 and the $16,000 deductible amount in 2016 will not be realizable because it cannot be carried
back and offset against 2013 taxable income. Deductible amounts totaling
$38,000 ($14,000 + $24,000) can be carried back, yielding a tax benefit of

$15,200 ($38,000 × 0.40). Note that because the tax benefit is realized
through carryback to 2013, the 2013 tax rate is used to compute the amount
of the tax benefit. A valuation allowance is needed to reduce the deferred
tax asset to its realizable amount. The following journal entry would be
added to those given in (1):
Income Tax Benefit...................................................................
Allowance to Reduce Deferred Tax
Asset to Realizable Value—Noncurrent.........................
($30,180 – $15,200)

14,980
14,980

16–39.
1.

Calculation of refund due:

Year
2011
2012

Income
$230,000
310,000
$540,000

Amount of 2013
Loss Applied
against Income

$230,000
310,000
$540,000

Income
Tax
Rate
42%
30

Amount of Refund
Due from Prior
Years
$ 96,600
93,000
$189,600

(Note: The loss in 2013 can be carried back for only two years. Thus, it
cannot be offset against taxable income reported in 2010.)
Amount of 2013 loss available for carryforward to future years:
2013 Net operating loss.......................................................
Less: Amount applied against prior years’ income .........
Amount available for carryforward ....................................

$ 820,000
540,000
$ 280,000


To download more slides, ebook, solutions and test bank, visit

Chapter 16

742

16–39. (Concluded)
2.

3.

Income Tax Refund Receivable..........................................
Income Tax Benefit from NOL Carryback....................
To record refund from applying operating
loss carryback.

189,600

Deferred Tax Asset from NOL Carryforward.....................
Income Tax Benefit from NOL Carryforward...............
($280,000 × 0.34 = $95,200)

95,200

Net operating loss before income tax benefit........................
Income tax benefit from NOL carryback and carryforward..
Net loss ................................................................................

189,600

95,200


$ (820,000)
284,800
$ (535,200)

16–40.
1.

Refund due: $45,000 + $9,000 = $54,000
(Note: The loss in 2013 can be carried back for only two years. Thus, it
cannot be offset against taxable income reported in 2010.)
Carryforward: $1,000,000 – $150,000 – $30,000 = $820,000

2.

Income Tax Refund Receivable...............................................
Income Tax Benefit—NOL Carryback ...............................

54,000
54,000

Deferred Tax Asset* ($820,000 × 0.40) .................................... 328,000
Income Tax Benefit—NOL Carryforward ..........................
328,000
*Classification of the deferred tax asset depends on the expected timing of
the utilization of the NOL carryforward.
3.

With Lexis’ downward trend in income in recent years, it is questionable
whether the NOL carryforward will ever be used. Even assuming that profitability is restored to the 2011 level, it will take more than five years to fully
utilize the NOL carryforward. Thus, it seems more likely than not that at

least some portion of the NOL carryforward will expire unused. Further evidence would be needed to estimate an appropriate valuation allowance.


To download more slides, ebook, solutions and test bank, visit
Chapter 16

743

16–41.
Cash flow from operations:
Increase in income taxes payable .........................
Decrease in deferred tax liability...........................

$ 6,000
(8,000)

Supplemental disclosure to the statement of cash flows should also report
$26,000 cash paid for income taxes ($32,000 current – $6,000 increase in
income taxes payable).
16–42.
1.

Cash flow from operations:
Increase in deferred tax asset ............................... $(28,000)
Increase in income tax refund receivable ............
(8,000)
Supplemental disclosure to the statement of cash flows should also report
$4,000 cash refund received for income taxes ($4,000 due at the end of
2012).


2.

Cash received from income tax refund ......................

$ 4,000


To download more slides, ebook, solutions and test bank, visit
Chapter 16

744

PROBLEMS
16–43.
2013 Income Tax Expense......................................................................
Income Taxes Payable .............................................................
Deferred Tax Liability—Noncurrent ........................................

15,470
10,080
5,390

Income tax expense: Current (0.35 × $28,800) + Deferred (0.35 × $15,400) = $15,470
(Classification Note: The deferred tax liability is classified
as noncurrent because the underlying receivable, to be
collected in 2015, is noncurrent as of December 31, 2013.)
2014 Income Tax Expense......................................................................
Income Taxes Payable .............................................................
($21,600 × 0.35)


7,560

Income Tax Expense......................................................................
Deferred Tax Liability—Current ..............................................
[($15,400 + $16,600) × 0.35] – $5,390 = $5,810

5,810

Deferred Tax Liability—Noncurrent..............................................
Deferred Tax Liability—Current ..............................................
To reclassify deferred tax liability recorded in 2013
because the underlying receivable is current as of
December 31, 2014.

5,390

2015 Income Tax Expense......................................................................
Income Taxes Payable .............................................................
($53,100 × 0.35)

18,585

Deferred Tax Liability—Current ....................................................
Income Tax Benefit...................................................................
($5,810 + $5,390 = $11,200)

11,200

7,560


5,810

5,390

18,585

11,200

The income tax benefit account offsets the income tax expense account.
16–44.
1.

Taxable income .................................................................
Add temporary difference:
Tax depreciation in excess of book depreciation ....
Pretax financial income subject to tax............................
Add permanent differences:
Proceeds from life insurance policy.......................... $145,000
Interest revenue on municipal bonds........................ 107,000
Pretax financial income ....................................................

$2,340,000
310,000
$2,650,000

252,000
$2,902,000


To download more slides, ebook, solutions and test bank, visit

Chapter 16

745

16–44. (Concluded)
2.
2013 Income Tax Expense............................................................
Income Taxes Payable ...................................................
($2,340,000 × 0.35)

819,000
819,000

Income Tax Expense............................................................
Deferred Tax Liability—Noncurrent ..............................
($310,000 × 0.35)

108,500
108,500

3.
Polytechnic Corporation
Partial Income Statement
For the Year Ended December 31, 2013
Income from continuing operations before income taxes ....
Income taxes on continuing operations:
Current provision.................................................................
Deferred provision ...............................................................
Net income .................................................................................


$ 2,902,000
$819,000
108,500

927,500
$ 1,974,500

16–45.
1. Income Tax Expense ......................................................................
Income Taxes Payable ..............................................................
($67,500 × 0.40)
Pretax financial income .................................................
Nondeductible expenses ...............................................
Nontaxable revenues .....................................................
Gross profit on installment sales .................................
Taxable income ..............................................................

27,000

$ 90,000
25,000
(15,500)
(32,000)
$ 67,500

Income Tax Expense ........................................................................... 10,445
Deferred Tax Liability—Current ....................................................
Deferred Tax Liability—Noncurrent..............................................

2014

2015
2016

Enacted
Rate
35%
33
30

Taxable
Amount
$ 7,000
16,500
8,500
$32,000

27,000

2,450
7,995

Liability
Valuation
$ 2,450
5,445
2,550
$ 10,445

(Classification Note: The receivable from the installment sale would be classified
according to the time of its expected collection. At December 31, 2013, $7,000

would be classified as current and $25,000 as noncurrent. The classification of the
deferred tax liability mirrors this split.)