- CFA Exams
- CFA Level I Exam
- Topic 4. Financial Statement Analysis
- Learning Module 9. Analysis of Income Taxes
- Subject 4. Temporary versus Permanent Differences
CFA Practice Question
Clemens Corporation uses the allowance method to recognize bad debts for book purposes and the direct write-off approach, as required, for tax purposes. Assuming Clemens did not write off any bad debts (under GAAP) in their first year, they would recognize ______.
B. a temporary difference as a deferred tax liability
C. no deferred tax asset or liability
A. a temporary difference as a deferred tax asset
B. a temporary difference as a deferred tax liability
C. no deferred tax asset or liability
Correct Answer: A
The difference between bad debt expense for book purposes and the zero bad debt expense for tax purposes results in a temporary difference. In the future, Clemens will expect to realize the tax benefits from the actual account write-offs. Therefore, they have a deferred tax asset.
User Contributed Comments 10
| User | Comment |
|---|---|
| LondonBoy | I'm not sure about this? Isn't this the same as a depreciation expense, and therefore a deferred tax liability? |
| lami | It's still the same principle. since the tax officer would not recognise any bad debt, the taxable income would be higher than the accounting income. Thia would bring about a deffered tax asset since the company would be paying more now and would receive little later. |
| uberstyle | isn't it saying they are not writing off any bad debt in the first year to accounting (not taking a reduction in pretax income)? This seems like it would mean pretax income>taxable income which infers deferred tax liabilities. What am I missing? |
| tonypractice | i also felt that no amount was charged against accounting income and therefore pretax income=taxable income ...meaning no def tax asset or liability |
| kutta2102 | Uberstyle, the 'allowance' method will result in a 'bad debt expense' on financial reporting, reducing the pre-tax income. Since there were no actual write-offs during the year, the taxable income will be higher by an amount equal to the bad debt expense. Therefore, taxable income > pre-tax income which should result in a deferred tax asset. |
| moneyguy | Just when I think I understand the difference between DTL and DTA, I become confused again. They couldn't make this stuff more complicated if they tried! |
| johntan1979 | As much as I hate taxes, I'm starting to understand this crap... 1. Tax reporting uses write-off method but did not write-off anything. 2. Financial reporting uses allowance method, so pretax income is lower and therefore, lower tax expense. 3. Tax expense < tax payable = DTA |
| Shaan23 | Yup - in the same boat as John. Hate it to but am starting to get it. |
| robbiecow | 1. The Allowance method creates a contra-asset called the Allowance for Doubtful Accounts. You would debit Bad Debt Expense and credit Allowance for Doubtful Accounts. 2. As for the direct write-off approach you would debit Bad Debt Expense and credit Accounts Receivable. Note that in order for you to capture something in the Bad Debt Expense under the Direct Write-Off method something MUST be written off. As johntan1979 points out, you did not write anything off for tax purposes so your Bad Debt Expense under 2 is zero. The difference between this zero Bad Debt Exp. and what was put forth under the allowance method creates a temporary difference. |
| Freddie33 | I just don't get this crap. Ffs |