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CPA Financial Accounting and Reporting Far Quiz

CPA Financial Accounting and Reporting Far Quiz: Account For Permanent And Temporary Differences

Practice Account For Permanent And Temporary Differences in CPA Financial Accounting and Reporting Far with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

Question 1 / 20

0 of 20 answered

Which of the following is a permanent difference between book income and taxable income?

Select an answer to continue

What this quiz covers

This quiz focuses on Account For Permanent And Temporary Differences, giving you a quick way to practice the rules, question types, and explanations that matter most for CPA Financial Accounting and Reporting Far.

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

All questions

Question 1

Which of the following is a permanent difference between book income and taxable income?

  1. Accelerated depreciation for tax purposes versus straight-line for book purposes.
  2. Tax-exempt municipal bond interest income. (correct answer)
  3. Warranty expense accrued for book but deductible for tax when paid.
  4. Deferred revenue recognized for book but taxed when received.

Explanation: 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.

Question 2

Which of the following creates a deferred tax liability?

  1. Warranty costs accrued for book purposes but not yet deductible for tax.
  2. Rent received in advance that is taxable when received but recognized for book purposes when earned.
  3. A net operating loss carryforward.
  4. Accelerated depreciation taken for tax purposes in excess of straight-line depreciation recorded for book purposes. (correct answer)

Explanation: 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.

Question 3

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?

  1. $0; warranty costs are a permanent difference.
  2. $50,000
  3. $37,500
  4. $12,500 (correct answer)

Explanation: Warranty expense accrued for book but deductible for tax when paid creates a temporary difference. The deferred tax asset = temporary difference x tax rate = 50,000x2550,000 x 25% = 50,000x2512,500. 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.

Question 4

Which of the following is NOT a temporary difference under ASC 740?

  1. Proceeds from life insurance on a key employee. (correct answer)
  2. Unrealized gains on investments recognized for book but not yet taxable.
  3. Installment sales recognized for book at point of sale but taxed when cash is collected.
  4. Depreciation timing differences between book and tax methods.

Explanation: 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.

Question 5

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?

  1. Deferred tax liability of $25,000.
  2. Deferred tax asset of $25,000 with no valuation allowance. (correct answer)
  3. Deferred tax asset of $100,000.
  4. No entry; NOL carryforwards are disclosed only.

Explanation: An NOL carryforward represents a future deductible amount, creating a deferred tax asset = 100,000x25100,000 x 25% = 100,000x2525,000. 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.

Question 6

A company uses the straight-line method for book depreciation and accelerated MACRS for tax depreciation. In Year 1, book depreciation is 20,000andtaxdepreciationis20,000 and tax depreciation is 20,000andtaxdepreciationis35,000. The tax rate is 25%. What deferred tax liability is created in Year 1?

  1. $5,000
  2. $8,750
  3. $3,750 (correct answer)
  4. $15,000

Explanation: The excess of tax depreciation over book depreciation creates a taxable temporary difference: 35,000−35,000 - 35,000−20,000 = 15,000.Deferredtaxliability=15,000. Deferred tax liability = 15,000.Deferredtaxliability=15,000 x 25% = $3,750. Answer C is correct. Answer A applies a 33% tax rate to the difference. Answer B applies 25% to the full tax depreciation amount. Answer D uses the gross temporary difference without applying the tax rate.

Question 7

A company has pretax book income of 300,000anda21300,000 and a 21% statutory tax rate. Permanent differences include 300,000anda2110,000 of tax-exempt municipal bond interest and $5,000 of nondeductible fines. What is the effective tax rate?

  1. Approximately 20.65% (correct answer)
  2. 21%
  3. Approximately 21.35%
  4. Approximately 22.75%

Explanation: Taxable income = 300,000−300,000 - 300,000−10,000 (exempt interest) + 5,000(nondeductiblefines)=5,000 (nondeductible fines) = 5,000(nondeductiblefines)=295,000. Current tax = 295,000x21295,000 x 21% = 295,000x2161,950. Effective tax rate = 61,950/61,950 / 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.

Question 8

Which of the following correctly describes the 'more likely than not' threshold for recognizing a deferred tax asset under ASC 740?

  1. The deferred tax asset is recognized only if realization is virtually certain.
  2. The deferred tax asset is recognized only if realization is reasonably possible.
  3. The deferred tax asset is recognized in full and a valuation allowance reduces it if realization of any portion is less than 50% likely. (correct answer)
  4. The deferred tax asset is recognized only if the company has taxable income in all prior years.

Explanation: Under ASC 740, a deferred tax asset is always recognized in full. A valuation allowance is then established for any portion where realization is more likely than not to not occur - meaning there is greater than 50% chance that portion will not be realized. The threshold is 'more likely than not,' which means greater than 50% probability. Answer C correctly describes this two-step approach. Answer A sets too high a bar (virtually certain). Answer B sets too low a bar (reasonably possible). Answer D conditions recognition on a historical profit record, which is not the ASC 740 standard.

Question 9

A company reports 180,000ofpretaxbookincome.Temporarydifferences:excesstaxdepreciationof180,000 of pretax book income. Temporary differences: excess tax depreciation of 180,000ofpretaxbookincome.Temporarydifferences:excesstaxdepreciationof30,000 (taxable temporary difference) and warranty accruals of $12,000 (deductible temporary difference). The tax rate is 21%. What is total income tax expense?

  1. $37,800 (correct answer)
  2. $34,020
  3. $41,580
  4. $42,000

Explanation: Total income tax expense is based on pretax book income, not taxable income: 180,000x21180,000 x 21% = 180,000x2137,800. The current and deferred components net to this total. Taxable income = 180,000−180,000 - 180,000−30,000 (excess tax depreciation reduces taxable income) + 12,000(warrantyaccrualsnotyetdeductibleincreasetaxableincome)=12,000 (warranty accruals not yet deductible increase taxable income) = 12,000(warrantyaccrualsnotyetdeductibleincreasetaxableincome)=162,000. Current tax = 162,000x21162,000 x 21% = 162,000x2134,020. Deferred tax expense (net) = (30,000−30,000 - 30,000−12,000) x 21% = 18,000x2118,000 x 21% = 18,000x213,780. Total income tax expense = 34,020+34,020 + 34,020+3,780 = $37,800. Answer A is correct. Answer B is only the current tax portion. Answer C applies the rate to taxable income inclusive of only the depreciation difference. Answer D approximates without precise calculation.

Question 10

A company's effective tax rate is 18%, while the statutory federal rate is 21%. Which of the following most likely explains this difference?

  1. Nondeductible meals and entertainment expenses.
  2. Tax-exempt income from municipal bonds. (correct answer)
  3. Accelerated depreciation for tax purposes.
  4. A valuation allowance established against a deferred tax asset.

Explanation: When the effective tax rate is below the statutory rate, the company has items that reduce taxable income permanently relative to book income. Tax-exempt income (such as municipal bond interest) is recognized in book income but never subject to tax, reducing the effective rate below the statutory rate. Answer B is correct. Nondeductible M&E (A) increases taxable income above book income, pushing the effective rate above the statutory rate. Accelerated depreciation (C) is a temporary difference that affects current vs. deferred tax but does not change total income tax expense or the effective rate over time. A valuation allowance (D) increases income tax expense, raising the effective rate above the statutory rate.

Question 11

A company recognizes 90,000ofsubscriptionrevenueratablyover3yearsforbookpurposes,butthefull90,000 of subscription revenue ratably over 3 years for book purposes, but the full 90,000ofsubscriptionrevenueratablyover3yearsforbookpurposes,butthefull90,000 is taxable when received in Year 1. The tax rate is 25%. What is the deferred tax balance at the end of Year 1?

  1. Deferred tax asset of $15,000. (correct answer)
  2. Deferred tax liability of $15,000.
  3. Deferred tax asset of $22,500.
  4. No deferred tax; subscription revenue is a permanent difference.

Explanation: In Year 1, 90,000istaxedbutonly90,000 is taxed but only 90,000istaxedbutonly30,000 (90,000/3)isrecognizedasbookrevenue.Theremaining90,000 / 3) is recognized as book revenue. The remaining 90,000/3)isrecognizedasbookrevenue.Theremaining60,000 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 = 60,000x2560,000 x 25% = 60,000x2515,000. 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.

Question 12

Under ASC 740, deferred tax assets and liabilities are classified on the balance sheet as:

  1. Current or noncurrent based on the classification of the related asset or liability.
  2. Current only, since all temporary differences are expected to reverse within one year.
  3. All noncurrent, presented as a single net amount. (correct answer)
  4. Separately as current and noncurrent, never netted.

Explanation: 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.

Question 13

A company has book income before taxes of 200,000.Temporarydifferencesresultintaxableincomeof200,000. Temporary differences result in taxable income of 200,000.Temporarydifferencesresultintaxableincomeof240,000. The enacted tax rate is 21%. What is the current tax expense and the deferred tax benefit?

  1. Current tax expense 42,000;deferredtaxexpense42,000; deferred tax expense 42,000;deferredtaxexpense8,400.
  2. Current tax expense $42,000; no deferred tax.
  3. Current tax expense 50,400;deferredtaxbenefit50,400; deferred tax benefit 50,400;deferredtaxbenefit8,400. (correct answer)
  4. Current tax expense 50,400;deferredtaxexpense50,400; deferred tax expense 50,400;deferredtaxexpense8,400.

Explanation: Current tax expense = taxable income x tax rate = 240,000x21240,000 x 21% = 240,000x2150,400. Taxable income exceeds book income by 40,000,meaningthecompanyispayingmoretaxnowthanitsbookincomewouldindicate.Thisexcesswillbedeductible(oroffset)inthefuture,creatingadeferredtaxasset−adeferredtaxbenefit=40,000, meaning the company is paying more tax now than its book income would indicate. This excess will be deductible (or offset) in the future, creating a deferred tax asset - a deferred tax benefit = 40,000,meaningthecompanyispayingmoretaxnowthanitsbookincomewouldindicate.Thisexcesswillbedeductible(oroffset)inthefuture,creatingadeferredtaxasset−adeferredtaxbenefit=40,000 x 21% = 8,400.Totalincometaxexpense=8,400. Total income tax expense = 8,400.Totalincometaxexpense=50,400 - 8,400=8,400 = 8,400=42,000, which equals book income x rate. Answer C is correct. Answer A understates current tax by using book income. Answers B and D misstate the deferred component.

Question 14

A company has pretax book income of 500,000.Ithas500,000. It has 500,000.Ithas20,000 of tax-exempt interest and $15,000 of nondeductible meals and entertainment expenses. What is the company's taxable income?

  1. $500,000
  2. $515,000
  3. $480,000
  4. $495,000 (correct answer)

Explanation: 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 = 500,000−500,000 - 500,000−20,000 + 15,000=15,000 = 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+500,000 + 500,000+15,000 = 515,000). Answer C subtracts only the exempt interest without adding M&E (500,000 - 20,000=20,000 = 20,000=480,000).

Question 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?

  1. Temporary difference - deferred tax asset.
  2. Permanent difference - increases the effective tax rate. (correct answer)
  3. Temporary difference - deferred tax liability.
  4. Temporary difference that reverses in the year the fine is paid.

Explanation: 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.

Question 16

A company receives $120,000 of rental income in December Year 1, which is taxable in Year 1 but will be recognized as book revenue in Year 2 when earned. The tax rate is 30%. What is the deferred tax asset or liability at December 31, Year 1?

  1. Deferred tax liability of $36,000.
  2. Deferred tax asset of $36,000. (correct answer)
  3. Deferred tax liability of $120,000.
  4. No deferred tax; this is a permanent difference.

Explanation: The company paid tax on 120,000inYear1buthasnotyetrecognizedtherevenueforbookpurposes.InYear2,bookincomewillinclude120,000 in Year 1 but has not yet recognized the revenue for book purposes. In Year 2, book income will include 120,000inYear1buthasnotyetrecognizedtherevenueforbookpurposes.InYear2,bookincomewillinclude120,000 but taxable income will not - the tax has already been paid. This creates a future deductible amount (relative to book income), which is a deferred tax asset = 120,000x30120,000 x 30% = 120,000x3036,000. Answer B is correct. Answer A records a liability when an asset is warranted. Answer C uses the gross amount rather than the tax effect. Answer D incorrectly classifies this timing difference as permanent.

Question 17

At year-end, a company has a deferred tax asset of 80,000anddeterminesthatitismorelikelythannotthat80,000 and determines that it is more likely than not that 80,000anddeterminesthatitismorelikelythannotthat30,000 of the asset will not be realized. What journal entry is required?

  1. Debit Deferred Tax Asset 30,000;CreditIncomeTaxExpense30,000; Credit Income Tax Expense 30,000;CreditIncomeTaxExpense30,000.
  2. Debit Deferred Tax Asset 80,000;CreditValuationAllowance80,000; Credit Valuation Allowance 80,000;CreditValuationAllowance80,000.
  3. No entry required; the full deferred tax asset is retained.
  4. Debit Income Tax Expense 30,000;CreditValuationAllowance30,000; Credit Valuation Allowance 30,000;CreditValuationAllowance30,000. (correct answer)

Explanation: 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 30,000unlikely−to−be−realizedportionrequiresanallowance.AnswerDiscorrect.AnswerAreversesthedebitandcredit.AnswerBestablishestheallowanceforthefull30,000 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 30,000unlikely−to−be−realizedportionrequiresanallowance.AnswerDiscorrect.AnswerAreversesthedebitandcredit.AnswerBestablishestheallowanceforthefull80,000 rather than just the $30,000 not expected to be realized. Answer C ignores the required valuation allowance.

Question 18

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?

  1. Deferred tax liability of $15,000. (correct answer)
  2. Deferred tax asset of $15,000.
  3. No deferred tax; revenue timing is a permanent difference.
  4. Deferred tax liability of $60,000.

Explanation: Book income exceeds taxable income by 60,000inYear1becauserevenueisrecognizedforbookbutnotyettaxed.InYear2,the60,000 in Year 1 because revenue is recognized for book but not yet taxed. In Year 2, the 60,000inYear1becauserevenueisrecognizedforbookbutnotyettaxed.InYear2,the60,000 will be taxable with no corresponding book income, creating a future taxable amount. This is a taxable temporary difference - a deferred tax liability = 60,000x2560,000 x 25% = 60,000x2515,000. 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.

Question 19

At the beginning of Year 2, a company has a deferred tax liability of 42,000relatedtodepreciationtiming.DuringYear2,excesstaxdepreciationoverbookdepreciationis42,000 related to depreciation timing. During Year 2, excess tax depreciation over book depreciation is 42,000relatedtodepreciationtiming.DuringYear2,excesstaxdepreciationoverbookdepreciationis10,000 on new assets, and 20,000ofpriordepreciationtimingdifferencesreverseasbookdepreciationexceedstaxdepreciationonolderassets.Also,20,000 of prior depreciation timing differences reverse as book depreciation exceeds tax depreciation on older assets. Also, 20,000ofpriordepreciationtimingdifferencesreverseasbookdepreciationexceedstaxdepreciationonolderassets.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?

  1. $44,100
  2. $46,200
  3. $39,900 (correct answer)
  4. $37,800

Explanation: Opening DTL = 42,000(depreciationtiming).DuringYear2:newexcesstaxdepreciationadds42,000 (depreciation timing). During Year 2: new excess tax depreciation adds 42,000(depreciationtiming).DuringYear2:newexcesstaxdepreciationadds10,000 x 21% = 2,100totheDTL.PriordepreciationtimingreversalreducestheDTLby2,100 to the DTL. Prior depreciation timing reversal reduces the DTL by 2,100totheDTL.PriordepreciationtimingreversalreducestheDTLby20,000 x 21% = 4,200.NetDTL=4,200. Net DTL = 4,200.NetDTL=42,000 + 2,100−2,100 - 2,100−4,200 = 39,900.ThewarrantyclaimspaidinYear2reverseapriordeferredtaxassetbutdonotaffectthedeferredtaxliability.AnswerCiscorrect.AnswerAaddsonlythenewDTLwithoutthereversal(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 (39,900.ThewarrantyclaimspaidinYear2reverseapriordeferredtaxassetbutdonotaffectthedeferredtaxliability.AnswerCiscorrect.AnswerAaddsonlythenewDTLwithoutthereversal(42,000 + 2,100=2,100 = 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.

Question 20

A company has the following items: (1) 40,000excessoftaxdepreciationoverbookdepreciation;(2)40,000 excess of tax depreciation over book depreciation; (2) 40,000excessoftaxdepreciationoverbookdepreciation;(2)10,000 of interest on municipal bonds; (3) 25,000ofwarrantyaccrualsnotyetdeductiblefortax;(4)25,000 of warranty accruals not yet deductible for tax; (4) 25,000ofwarrantyaccrualsnotyetdeductiblefortax;(4)8,000 of nondeductible officer life insurance premiums. Which items create a deferred tax liability?

  1. Items 1 and 3
  2. Items 2 and 4
  3. Items 3 and 4
  4. Item 1 only (correct answer)

Explanation: 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.