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Account For Permanent And Temporary Differences - CPA Far

  1. Under ASC 740, deferred tax assets and liabilities are classified on the balance sheet as:
    Answer: All noncurrent, presented as a single net amount. Under ASU 2015-17, all deferred tax assets and liabilities are classified as noncurrent on the balance sheet. They are presented as a single net noncurrent amount (net DTA or net DTL) within the same tax jurisdiction. Answer C is correct. Answer A describes the prior guidance that classified deferred taxes as current or noncurrent based on the underlying asset or liability - this approach was eliminated by ASU 2015-17. Answer B is incorrect; deferred taxes are not all classified as current. Answer D is incorrect; deferred taxes within the same jurisdiction are netted, not presented separately as current and noncurrent.
  2. Which of the following is NOT a temporary difference under ASC 740?
    Answer: Proceeds from life insurance on a key employee. Proceeds from company-owned life insurance are permanently excluded from taxable income - they never create a taxable or deductible amount in future periods. This is a permanent difference, not a temporary one. Answer A is correct. Unrealized gains (B), installment sales (C), and depreciation timing (D) all create temporary differences that reverse over time.
  3. A company has the following items: (1) $40,000 excess of tax depreciation over book depreciation; (2) $10,000 of interest on municipal bonds; (3) $25,000 of warranty accruals not yet deductible for tax; (4) $8,000 of nondeductible officer life insurance premiums. Which items create a deferred tax liability?
    Answer: Item 1 only A deferred tax liability arises when taxable income is lower than book income (tax is deferred to the future). Excess tax depreciation (Item 1) reduces taxable income below book income now, creating a future taxable amount - a deferred tax liability. Item 2 (municipal bond interest) is a permanent difference - no deferred tax. Item 3 (warranty accruals) creates a deferred tax asset (future deductible amount). Item 4 (nondeductible life insurance) is a permanent difference - no deferred tax. Answer D is correct.
  4. A company has pretax book income of $300,000 and a 21% statutory tax rate. Permanent differences include $10,000 of tax-exempt municipal bond interest and $5,000 of nondeductible fines. What is the effective tax rate?
    Answer: Approximately 20.65% Taxable income = $300,000 - $10,000 (exempt interest) + $5,000 (nondeductible fines) = $295,000. Current tax = $295,000 x 21% = $61,950. Effective tax rate = $61,950 / $300,000 = 20.65%. Answer A is correct. The tax-exempt interest saves more tax than the fines add, pulling the rate below 21%. Answer B applies only if no permanent differences exist. Answer C would result if only the fines existed. Answer D overstates the effective rate.
  5. A company accrues $50,000 of warranty expense for book purposes. The expense is deductible for tax only when warranty claims are paid. The enacted tax rate is 25%. What deferred tax asset should be recognized?
    Answer: $12,500 Warranty expense accrued for book but deductible for tax when paid creates a temporary difference. The deferred tax asset = temporary difference x tax rate = $50,000 x 25% = $12,500. Answer D is correct. Answer A incorrectly classifies this as a permanent difference - warranty timing reverses when claims are paid. Answer B uses the full pretax amount without applying the tax rate. Answer C applies a 75% factor rather than the 25% tax rate.
  6. Which of the following is a permanent difference between book income and taxable income?
    Answer: Tax-exempt municipal bond interest income. Permanent differences arise from items included in book income but never in taxable income, or vice versa. Municipal bond interest is exempt from federal income tax permanently - it is never taxable. Answer B is correct. Accelerated depreciation (A) creates a temporary difference that reverses over the asset's life. Warranty accruals (C) and deferred revenue (D) both reverse when the related cash transaction occurs - these are temporary differences.
  7. Titan Corp. has enacted tax rates of 21% for 2024, 25% for 2025-2026, and 28% for 2027 and beyond. At December 31, 2024, Titan has temporary differences that will reverse as follows: $60,000 taxable amount in 2025, $80,000 deductible amount in 2026, and $40,000 taxable amount in 2028. Titan also has a $200,000 NOL carryforward from 2023 that expires in 2028. Management believes it is more likely than not that only $150,000 of the NOL will be realized. What is the net deferred tax asset that Titan should report at December 31, 2024?
    Answer: $35,000 Calculate each deferred tax component using appropriate tax rates. Deferred tax liability for 2025 taxable amount: $60,000 × 25% = $15,000. Deferred tax asset for 2026 deductible amount: $80,000 × 25% = $20,000. Deferred tax liability for 2028 taxable amount: $40,000 × 28% = $11,200. Deferred tax asset for NOL carryforward: $200,000 × 28% (rate when it expires) = $56,000. However, only $150,000 is expected to be realized, so the net deferred tax asset for the NOL after valuation allowance = $150,000 × 28% = $42,000. Total deferred tax assets = $20,000 + $42,000 = $62,000. Total deferred tax liabilities = $15,000 + $11,200 = $26,200. Net deferred tax asset = $62,000 - $26,200 = $35,800, which rounds to $35,000.
  8. Which of the following creates a deferred tax liability?
    Answer: Accelerated depreciation taken for tax purposes in excess of straight-line depreciation recorded for book purposes. A deferred tax liability arises when taxable income is less than book income in the current period, meaning more tax will be owed in the future. Accelerated tax depreciation reduces taxable income now relative to book income, creating a future taxable amount when the timing reverses. Answer D is correct. Warranty accruals (A) create a deferred tax asset - the deduction occurs in the future when claims are paid, creating a future deductible amount. Rent received in advance that is taxable when received (B) also creates a deferred tax asset - tax is paid before book income is recognized. A net operating loss carryforward (C) creates a deferred tax asset because it can reduce future taxable income.
  9. A company has a $100,000 net operating loss (NOL) carryforward. The enacted tax rate is 25%. Management determines it is more likely than not that the full NOL will be utilized. What is the correct balance sheet presentation?
    Answer: Deferred tax asset of $25,000 with no valuation allowance. An NOL carryforward represents a future deductible amount, creating a deferred tax asset = $100,000 x 25% = $25,000. Because management has determined it is more likely than not that the full NOL will be utilized, no valuation allowance is needed. Answer B is correct. Answer A records a liability rather than an asset. Answer C uses the gross NOL rather than the tax-effected amount. Answer D incorrectly omits recognition.
  10. A company begins Year 2 with a deferred tax liability of $15,000 related to installment sale revenue recognized for book in Year 1 but taxable when cash is collected. During Year 2, the company collects $30,000 of installment payments (now taxable with no corresponding book income) and recognizes $50,000 of new installment sales for book purposes (not yet taxable). The tax rate is 25%. What is the deferred tax liability at December 31, Year 2?
    Answer: $20,000 The deferred tax liability reverses when taxable income exceeds book income (collections). It increases when book income exceeds taxable income (new installment sales recognized). Reversal: $30,000 x 25% = $7,500 decrease. New addition: $50,000 x 25% = $12,500 increase. Ending DTL = $15,000 - $7,500 + $12,500 = $20,000. Answer C is correct. Answer A makes no adjustment for Year 2 activity. Answer B adds the $12,500 new DTL without deducting the $7,500 reversal ($15,000 + $12,500 = $27,500). Answer D deducts only the reversal without adding the new installment sales DTL ($15,000 - $7,500 = $7,500).
  11. A company recognizes $60,000 of revenue for book purposes in Year 1, but the revenue is not taxable until Year 2. The tax rate is 25%. What deferred tax balance should be recorded at December 31, Year 1?
    Answer: Deferred tax liability of $15,000. Book income exceeds taxable income by $60,000 in Year 1 because revenue is recognized for book but not yet taxed. In Year 2, the $60,000 will be taxable with no corresponding book income, creating a future taxable amount. This is a taxable temporary difference - a deferred tax liability = $60,000 x 25% = $15,000. Answer A is correct. Answer B records an asset when a liability is warranted. Answer C incorrectly treats this as permanent. Answer D uses the gross amount without applying the tax rate.
  12. Which of the following items creates a deductible temporary difference, giving rise to a deferred tax asset?
    Answer: Estimated losses on litigation accrued for book but deductible for tax only when paid. A deductible temporary difference creates a deferred tax asset because a future tax deduction will reduce taxable income. Estimated litigation losses accrued for book but not yet deductible for tax will produce a tax deduction when the claims are paid - a future deductible amount. Answer C is correct. Installment sales (A) create a deferred tax liability (book income first, tax later). Excess tax depreciation (B) creates a deferred tax liability (tax deduction first). Bond discount accelerated at issuance for tax (D) creates a deferred tax liability (tax deduction taken before book amortization).
  13. A company has pretax book income of $500,000. It has $20,000 of tax-exempt interest and $15,000 of nondeductible meals and entertainment expenses. What is the company's taxable income?
    Answer: $495,000 Permanent differences adjust book income to arrive at taxable income but never reverse. Tax-exempt interest reduces taxable income below book income: subtract $20,000. Nondeductible M&E increases taxable income above book income: add $15,000. Taxable income = $500,000 - $20,000 + $15,000 = $495,000. Answer D is correct. Answer A ignores both permanent differences and equals pretax book income. Answer B adds only the M&E without subtracting exempt interest ($500,000 + $15,000 = $515,000). Answer C subtracts only the exempt interest without adding M&E ($500,000 - $20,000 = $480,000).
  14. Vega Corporation reported pretax book income of $1,200,000 for 2024. Analysis reveals the following: (1) Book depreciation exceeded tax depreciation by $90,000, (2) Warranty costs of $55,000 were accrued for book purposes but only $35,000 was paid (and deducted for tax), (3) Vega received $30,000 of tax-exempt municipal bond interest, (4) Fines and penalties of $25,000 were expensed for book purposes but are non-deductible for tax, and (5) Rent collected in advance of $40,000 was included in taxable income in 2023 but is being recognized for book purposes in 2024. If the tax rate is 25% for all years and Vega had no beginning deferred tax balances, what is the total income tax expense for 2024?
    Answer: $308,750 First, calculate current taxable income: Start with book income $1,200,000, subtract municipal bond interest $30,000, add fines and penalties $25,000, add excess book depreciation $90,000, add warranty expense not yet paid $20,000 ($55,000 - $35,000), and subtract advance rent already taxed $40,000. Taxable income = $1,200,000 - $30,000 + $25,000 + $90,000 + $20,000 - $40,000 = $1,265,000. Current tax expense = $1,265,000 × 25% = $316,250. Next, calculate deferred taxes: Excess book depreciation creates deferred tax asset of $90,000 × 25% = $22,500. Excess warranty accrual creates deferred tax asset of $20,000 × 25% = $5,000. Advance rent creates deferred tax liability of $40,000 × 25% = $10,000. Net deferred tax asset = $22,500 + $5,000 - $10,000 = $17,500. Total income tax expense = Current tax expense - Net increase in deferred tax asset = $316,250 - $7,500 = $308,750.
  15. Fines and penalties paid to the government for violation of a law are deducted for book purposes but are nondeductible for tax purposes. How are these classified under ASC 740?
    Answer: Permanent difference - increases the effective tax rate. Fines and penalties paid to government agencies are permanently nondeductible for federal income tax purposes. They are expensed for book but never deducted for tax - this is a permanent difference. Because the expense reduces book income but not taxable income, taxable income is higher than book income, which increases the effective tax rate above the statutory rate. Answer B is correct. Answers A and C incorrectly classify this as a temporary difference. Answer D is incorrect because temporary differences reverse - fines never reverse.
  16. A company recognizes $90,000 of subscription revenue ratably over 3 years for book purposes, but the full $90,000 is taxable when received in Year 1. The tax rate is 25%. What is the deferred tax balance at the end of Year 1?
    Answer: Deferred tax asset of $15,000. In Year 1, $90,000 is taxed but only $30,000 ($90,000 / 3) is recognized as book revenue. The remaining $60,000 will be recognized as book revenue in Years 2 and 3 with no corresponding tax - a future deductible amount (the tax was already paid). Deferred tax asset = $60,000 x 25% = $15,000. Answer A is correct. Answer B records a liability when an asset exists. Answer C applies 25% to the full $90,000 rather than the unearned portion. Answer D incorrectly treats this as a permanent difference.
  17. A company has $200,000 of goodwill from a business combination that is amortizable for tax purposes over 15 years but not amortized for book purposes. At the end of Year 1, the tax basis of goodwill is $186,667 and the book basis is $200,000. What is the deferred tax effect?
    Answer: Deferred tax liability, because the tax basis is less than the book basis, resulting in a future taxable amount when the asset is sold. When the book basis of goodwill ($200,000) exceeds the tax basis ($186,667), there is a net taxable temporary difference. If the asset were sold, the taxable gain would exceed the book gain. This creates a deferred tax liability. Answer B is correct. Answer A reverses the correct direction. Answer C is incorrect - while the initial recognition exception applies to goodwill arising from a business combination in certain circumstances, the ongoing deferred tax from tax amortization creates a taxable temporary difference. Answer D is incorrect; tax deductions already taken reduce the tax basis, meaning future tax deductions will be less than book amortization (which is $0).
  18. Meridian Company has the following information for 2024: Book income before taxes $600,000, Tax depreciation exceeding book depreciation $90,000, Accrued vacation pay (not yet paid) $30,000, Interest on municipal bonds $20,000, Book warranty expense exceeding warranty payments $15,000, Non-deductible business meals $8,000. The tax rate is 21% for all years. What is the total income tax expense that Meridian should report in its 2024 income statement?
    Answer: $123,480 Total income tax expense consists of current tax expense plus the change in deferred tax liability minus the change in deferred tax asset. First, calculate current taxable income: $600,000 - $20,000 (municipal bonds) + $8,000 (non-deductible meals) - $90,000 (excess tax depreciation) + $30,000 (vacation pay accrual) + $15,000 (warranty expense accrual) = $543,000. Current tax expense = $543,000 × 21% = $114,030. Next, calculate deferred tax changes: Excess tax depreciation creates a $90,000 temporary difference that will reverse as taxable amounts, creating a deferred tax liability increase of $90,000 × 21% = $18,900. Vacation pay accrual creates a $30,000 temporary difference that will reverse as deductible amounts, creating a deferred tax asset increase of $30,000 × 21% = $6,300. Warranty expense accrual creates a $15,000 temporary difference that will reverse as deductible amounts, creating a deferred tax asset increase of $15,000 × 21% = $3,150. Total deferred tax asset increase = $6,300 + $3,150 = $9,450. Total income tax expense = Current tax expense + Increase in deferred tax liability - Increase in deferred tax asset = $114,030 + $18,900 - $9,450 = $123,480.
  19. At year-end, a company has a deferred tax asset of $80,000 and determines that it is more likely than not that $30,000 of the asset will not be realized. What journal entry is required?
    Answer: Debit Income Tax Expense $30,000; Credit Valuation Allowance $30,000. Under ASC 740, a valuation allowance is established for the portion of a deferred tax asset that is more likely than not to not be realized. The allowance is recorded by debiting Income Tax Expense and crediting Valuation Allowance. Only the $30,000 unlikely-to-be-realized portion requires an allowance. Answer D is correct. Answer A reverses the debit and credit. Answer B establishes the allowance for the full $80,000 rather than just the $30,000 not expected to be realized. Answer C ignores the required valuation allowance.
  20. At the beginning of Year 2, a company has a deferred tax liability of $42,000 related to depreciation timing. During Year 2, excess tax depreciation over book depreciation is $10,000 on new assets, and $20,000 of prior depreciation timing differences reverse as book depreciation exceeds tax depreciation on older assets. Also, $20,000 of prior warranty accruals (previously creating a deferred tax asset) become deductible when claims are paid. The tax rate is 21%. What is the net deferred tax liability at December 31, Year 2, assuming these are the only deferred tax items?
    Answer: $39,900 Opening DTL = $42,000 (depreciation timing). During Year 2: new excess tax depreciation adds $10,000 x 21% = $2,100 to the DTL. Prior depreciation timing reversal reduces the DTL by $20,000 x 21% = $4,200. Net DTL = $42,000 + $2,100 - $4,200 = $39,900. The warranty claims paid in Year 2 reverse a prior deferred tax asset but do not affect the deferred tax liability. Answer C is correct. Answer A adds only the new DTL without the reversal ($42,000 + $2,100 = $44,100). Answer B adds both the new DTL and the warranty reversal to the DTL incorrectly. Answer D subtracts too much from the opening balance.

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