- CFA Exams
- CFA Level I Exam
- Topic 4. Financial Statement Analysis
- Learning Module 9. Analysis of Income Taxes
- Subject 2. Deferred Tax Assets and Liabilities
CFA Practice Question
The following information relates to a profitable company that offers a warranty on a new product introduced in 2015:
Actual expenditures for repairs under the warranty in 2015: $200,000
B. Deferred tax asset of $65,000
C. Deferred tax liability of $35,000
Accrued warranty expenses for the warranty in 2015: $300,000
Actual expenditures for repairs under the warranty in 2015: $200,000
If the company's tax rate is 35 percent, which of the following most accurately describes the deferred tax recorded in 2015 with respect to the new product warranty?
A. Deferred tax asset of $35,000
B. Deferred tax asset of $65,000
C. Deferred tax liability of $35,000
Correct Answer: A
For financial statement purposes, the warranty expense recorded in 2015 is greater than the cash expense incurred (and that is allowed as a deduction for income tax purposes), resulting in a warranty liability for financial statement purposes, but not for tax purposes. As the carrying amount of the liability is greater than the amount of the tax base, the $100,000 temporary difference will give rise to a $35,000 (100,000 x 0.35) deferred tax asset.
User Contributed Comments 3
| User | Comment |
|---|---|
| Yrazzaq88 | Accrued = Financial Reporting Actual (Cash Basis) = Tax Reporting Tax Reporting = 200K Financial reporting = 300K Tax reporting (Tax Expense): 200K < F/S reporting (tax payable) of 300K = Deferred Asset Asset |
| dbedford | Because Financial Report Earnings after tax expense is lower (Earnings - $300k) than Tax Report Earnings (Earnings - $200k) the Tax Report taxes payable will be greater than the Financial Report Tax Expense resulting in a DTA. The difference is $100k @.35 tax rate = $35k. |
| gc1210 | @Yrazzaq88, when Tax Reporting is less than Financial Reporting, it means the firm is actually paying less at the current year, hents its a deferred tax liability, not a deferred tax asset. dbedford has the right explaination, the 200K and 300K are expenses, tax is not calculated based on expenses but on income, so the one with higher expense would result a lower income. In this case Financial Reporting has more expense hence lower income, and lower tax expense. The Tax Reporting has less expenditure, hence higher income, and high tax paid. IOW, what actually paid is more than what it should for the current year, hence DTA. |