CPA Financial Accounting and Reporting Far Quiz: Account For Permanent And Temporary Differences
20 questions · exam conditions
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Account For Permanent And Temporary DifferencesQuestion 1 of 20

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?

$0; warranty costs are a permanent difference.
$50,000
$37,500
$12,500
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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.

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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.

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Question 1

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 = $50,000 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.

Question 2

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 = $100,000 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.

Question 3

A company uses the straight-line method for book depreciation and accelerated MACRS for tax depreciation. In Year 1, book depreciation is $20,000 and tax depreciation is $35,000. 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 - $20,000 = $15,000. Deferred tax liability = $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 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?

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

Question 5

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 6

A company reports $180,000 of pretax book income. Temporary differences: excess tax depreciation of $30,000 (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: $180,000 x 21% = $37,800. The current and deferred components net to this total. Taxable income = $180,000 - $30,000 (excess tax depreciation reduces taxable income) + $12,000 (warranty accruals not yet deductible increase taxable income) = $162,000. Current tax = $162,000 x 21% = 34,020.Deferredtaxexpense(net)=(34,020. Deferred tax expense (net) = (30,000 - $12,000) x 21% = $18,000 x 21% = $3,780. Total income tax expense = $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 7

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?

  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, $90,000 is taxed but only 30,000(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.

Question 8

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 9

A company has book income before taxes of $200,000. Temporary differences result in taxable income of $240,000. The enacted tax rate is 21%. What is the current tax expense and the deferred tax benefit?

  1. Current tax expense $42,000; deferred tax expense $8,400.
  2. Current tax expense $42,000; no deferred tax.
  3. Current tax expense $50,400; deferred tax benefit $8,400. (correct answer)
  4. Current tax expense $50,400; deferred tax expense $8,400.
Explanation: Current tax expense = taxable income x tax rate = $240,000 x 21% = $50,400. Taxable income exceeds book income by $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 x 21% = $8,400. Total income tax expense = $50,400 - $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 10

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 $120,000 in Year 1 but has not yet recognized the revenue for book purposes. In Year 2, book income will include $120,000 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 = $120,000 x 30% = $36,000. 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 11

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?

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

Question 12

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 $60,000 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.

Question 13

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?

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

Question 14

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?

  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.

Question 15

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?

  1. $15,000
  2. $27,500
  3. $20,000 (correct answer)
  4. $7,500
Explanation: 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 7,500reversal(7,500 reversal (15,000 + $12,500 = 27,500).AnswerDdeductsonlythereversalwithoutaddingthenewinstallmentsalesDTL(27,500). Answer D deducts only the reversal without adding the new installment sales DTL (15,000 - $7,500 = $7,500).

Question 16

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?

  1. Deferred tax asset, because the book basis exceeds the tax basis.
  2. Deferred tax liability, because the tax basis is less than the book basis, resulting in a future taxable amount when the asset is sold. (correct answer)
  3. No deferred tax; goodwill differences from business combinations are excluded from ASC 740.
  4. Deferred tax asset, because future tax deductions exceed future book amortization.
Explanation: When the book basis of goodwill (200,000)exceedsthetaxbasis(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).

Question 17

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?

  1. $21,000
  2. $28,000
  3. $35,000 (correct answer)
  4. $42,000
Explanation: 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.

Question 18

Cosmos Inc. reported the following for the year ended December 31, 2024: Pretax book income $400,000, Municipal bond interest income $25,000, Life insurance premiums on key employees (Cosmos is beneficiary) $18,000, Life insurance proceeds received $75,000, Excess of book depreciation over tax depreciation $45,000, Accrued warranty costs not yet paid $32,000. The tax rate is 25%. Assuming no beginning deferred tax balances, what amount should Cosmos report as net deferred tax asset (liability) on its December 31, 2024 balance sheet?

  1. $(3,250) liability (correct answer)
  2. $(8,000) liability
  3. $3,250 asset
  4. $8,000 asset
Explanation: Identify temporary vs. permanent differences. Permanent differences (no deferred tax impact): Municipal bond interest $25,000, life insurance premiums $18,000, and life insurance proceeds $75,000. Temporary differences: Excess book depreciation over tax depreciation $45,000 will reverse as taxable amounts (creating deferred tax liability), and accrued warranty costs $32,000 will reverse as deductible amounts (creating deferred tax asset). Calculate deferred tax balances: Deferred tax liability = $45,000 × 25% = $11,250. Deferred tax asset = $32,000 × 25% = $8,000. Net deferred tax liability = $11,250 - $8,000 = $3,250. Since this is a net liability position, it should be reported as $(3,250) liability.

Question 19

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?

  1. $308,750 (correct answer)
  2. $313,750
  3. $318,750
  4. $323,750
Explanation: 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(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.

Question 20

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?

  1. $120,330
  2. $123,480 (correct answer)
  3. $126,630
  4. $129,780
Explanation: 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.