Assume U.S. GAAP. A company records the following two transactions:

I. $100,000 of rental revenue is received in advance on a two-year lease. It is taxed on a cash basis but deferred for accounting purposes.
II. There is $230,000 in installment sales. No payments are required for one year after which collections will be made on an equal basis over 12 months and taxed on a cash basis. The entire sale and related profit will be recognized for financial reporting purposes in the year of sale.

Which of the above transactions will most likely give rise to a deferred tax liability on the balance sheet?

Correct Answer: II only

II represents a deferred tax liability. The accounts receivable for financial statement purposes has a carrying value of $230,000 but a tax base of $0. The temporary difference creates a deferred tax liability. Alternatively, accounting income tax expense exceeded taxes payable and the firm expects to eliminate this difference over the course of future operations.

Item I represents a deferred tax asset. Rent received in advance creates a liability on the financial statements, with a carrying value of $100,000 but a tax base of $0. The temporary difference creates a deferred tax asset. Alternatively, an excess amount has been paid for income taxes based on the cash received (taxable income exceeded accounting income) and the company expects to recover this difference during the course of future operations.