- CFA Exams
- CFA Level I Exam
- Topic 3. Financial Statement Analysis
- Learning Module 24. Income Taxes
- Subject 3. Determining the Tax Base of Assets and Liabilities

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**CFA Practice Question**

Elon Company began operations on January 1, 2010 and reported pre-tax income of $400,000 and taxable income of $520,000 for their first year. Elon had a temporary difference relating to accrued product warranty costs that it expected to pay in the following manner: Year 2011, $40,000; Year 2012, $60,000, and Year 2013, $20,000. The enacted tax rates are 30% for 2010 and 2011, and 35% for 2012 and 2013. The deferred tax account at the end of 2010 is ______.

B. $36,000 deferred tax liability

C. $40,000 deferred tax asset

A. $36,000 deferred tax asset

B. $36,000 deferred tax liability

C. $40,000 deferred tax asset

Correct Answer: C

The computation is as follows: ($40,000 * 30%) + ($20,000 * 35%) + (60,000 * 35%). Since Elon has not yet realized the tax benefits from the warranty deductions, they have a deferred tax asset.

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**User Contributed Comments**
17

User |
Comment |
---|---|

kalps |
FUTURE FINANCIAL STAT INCOME WILL BE HIGHER THAN FUTURE TAXABLE INCOME AND THEREFORE WE HAVE A DEFERRED TAX ASSET |

robkaz |
(520,000-400,000)*.3+(60,000+20,000)*(.35-.30)=40,000 |

americade |
a better way to look at it and compute is: deferred tax asset = 30% * 120k = $36k plus: ($60k + 20k) * 5% = $4k total = $40k |

antarctica |
Why does deferred tax in 2010 take into account warranty costs incurred in later years? I thought warranty costs are only recognised each year they are incurred. |

gnja |
nope! you already recognize the whole warranty cost you expect to incur on the year you sold the warranty |

danrow |
I do not understand the answer: why you do not consider the difference between pre tax income and taxable income in year 1 (2010)? In the answer, you only consider the payments the company makes in 2011, 2012, and 2013. The tax asset should be considered since the first year, because they report the costs of the warranty in the financial statements and not in the tax returns. Can somebody explain why is only 40,000 (.30) + 20,000 (.35) + 60,000 (.35) without adding 120,000 (.30) Thanks |

thud |
The total amount of deferred assets = 120,000. All 40,000 (.30) + 20,000 (.35) + 60,000 (.35) does is split the deferred asset so it can apply the correct tax rates into the correct shares. If you add 120,000(0.30), you're double counting. |

merrick |
? pre tax income is low so accounting tax exp is high, theirfor tax payable is low= we have per paid making an asset. |

clarelau |
thud, good point~ |

gill15 |
I hate taxes |

johntan1979 |
Taxes sucks... I thought I got it, but now this question threw me back again... Please correct me if I am wrong... For 2010, taxable income = $520k Book income = $400k Taxes payable = Tax expense + DTA $520k x 0.3 = $400k x 0.3 + DTA DTA = $36,000 What happened to this DTA? I mean, I understand about adding the DTA for 2011, 2012 and 2013 but what happened to $36,000? Vanished? Poof? |

Ifi2703 |
This is actually very simple once you understand the question. Essentially, there is a difference between what the taxman believes is the income ($520k) and what the real income is ($400k). This means they will pay the higher tax but will now have a deferred asset by way of this overpayment. Total 'overstated' income is $120k and this is what they have split up into $40k, $60k and $20k. So, all you have to do is know that this is a deferred asset (eliminates option B) and then calculate the tax they are paying on each portion based on enacted tax rates for each year, and add it all up. This gives you the answer - $40k. |

jonan203 |
wow, i wish i took tax accounting in college...at least i got this one right! |

gill15 |
IF asked...how would we figure out the same thing for the end of the second year? |

GouldenOne |
I'm just going to know which ever answer I come up with is wrong and then i'll a 50% chance |

holtz |
lfi is simply killing it these days. imma start calling YOU the Taxman! |

Freddie33 |
This kind of question legit makes me want to smack my head on my desk |