CFA Practice Question

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CFA Practice Question

In 2011, its second year of operation, Superior Feeds, Inc. reported income before income tax for book purposes of $100,000. Tax depreciation was $10,000 and book depreciation was $9,000. At the end of 2010, Superior Feeds reported a deferred tax liability of $1,050. The statutory rate is 35% for 2010 and it is expected to remain the same in future years. Income taxes payable reported on the December 31, 2011 balance sheet are ______.

A. $34,650
B. $35,000
C. $35,350

Correct Answer: C

Income tax expense is $35,000 ($100,000 * 35%). The timing difference ($10,000 - $9,000) is a reversal of the 2010 deferred tax liability that decreases by $350 ($1,000 * 35%). Income taxes payable is $35,000 plus the deferred tax liability reduction of $350, or $35,350.

User Contributed Comments 33

User Comment
kalps Additional tax liability = (10000-9000)X0.35 = reversal of existing tax liability
robkaz How do we know the difference reverses in 2010? Deferred tax liability could keep growing. I appreciate any feed back. Thanks.
jamiejamie I don't see how we could assume the difference reverses given the information in the question. I wouldn't worry about it.
gjwhite It should be: tax depreciation of $9k and financial depreciation of $10k causing (pre-tax income)<(taxable income). Hence, (tax expense) < (taxes payable), causing a $350 deferred tax asset which partially off-sets the existing deferred tax liability of $1050. I am assuming there are no current(new) tax liabilities for 2010. So we have: taxes payable = (tax expense) + (current tax assets) - (current tax liabilities) =$35k+$350-0.
Nancyz I am confused. In the notes, it is emphasized that there should be no attempt to match income tax expense directly with pretax income. However, the answer go income tax expense directly using pretax income x rate, which contradicts with the notes.

My understanding is that Tax payable = (100,000-1,000) x 0.35=34,650. assuming 1,000 is the only temporary difference.

Tax expense= tax payable + changes in deferred tax liability = 34,650 + 350 = 35,000.

What do you all think?
ragingrazz Should that 2010 liability say $1,000, or what happens to the $50 difference?
stefdunk tax depreciation was greater than book depreciation, so book income was greater than tax income, so taxes on balance sheet are greater than taxes payed
mtcfa I agree with gwhite above. With tax depreciation greater than financial depreciation, the liability would only increase.
o123 yeah...the only way this would reverse the DTL is if it was the other way around....Tax depreciation = 9000, Book depreciation= 10000
Rotigga Here's My solution:
Taxes Payable = Tax Expense - Chg in Deferred Tax Liabilities + Chg in Deferred Tax Assets
Where Chg in Deferred Tax Liabilities = (Current - Previous Deferred Tax Liability)
Tax Expense = $100,000 * 0.35 = $35,000
Previous Deferred Tax Liability = $1,050
YE Deferred Tax Asset = ($9,000 - $10,000) * 0.35 = $350 Deferred Tax Asset
Thus, Current Deferred Tax Liability = $1,050 - $350 = $700
Chg in Deferred Tax Liabilities = -$350
Taxes Payable = $35,000 - (-$350) + ($0 - 0) = $35,350
Khadria Tax expense = 100,000 x 0.35 = 35,000
Tax Payable = 99,000 x 0.35 = 34,650
DTL for 2011 = 350
DTL for 2010 = 1050

With this data, its not possible to arrive at 35350 figure for income tax payabale for 2011.

I think there is misprint in the question. Actually, when they are talking about reversal, Tax Depreciation has to be less than the Book Depreciation i.e. 10000 is the book depreciation (and NOT the TAX DEPRECIATION as written in the question). Thinking this way:

Tax payable = 101000 * .35 = 35,350

rufi what is the difference between this and earlier question, #8?
hannovanwyk agree with gjwhite and rotigga
yael Following the question, your DTL should actually increase and not decrease.
kutta2102 I think the key assumption is that the $1,050 DTL from previous year will reverse itself out. I cannot understand why that's a logical assumption (since there's no such info given). The taxes payable should then be inclusive of $1050 and the DTL created in the current period($350).
dinozavr rottiga and kahdria - wrong


100,000 + 9,000 -10,000 = 99,000 taxable income
99,000*.35 +1050-350= 35,350
apiccion My thought process:

Book depreciation 9000
Tax depreciation 10,000
Difference -1000 => 1000*0.35 = 350 Deferred Tax ***Asset***

Note: Originally we had a deferred tax ***Liability*** we've gone from liability to asset. This means that the tax-reducing effect of depreciation has worn off, this implied a reversal. The easiest way to understand this is to take Example 1 on page 388 and extend to the year 2013.

Net Deferred Tax Liability = Deferred Tax Liabilities - Deferred Tax Assets
Net Deferred Tax Liability = 1050 - 350 = $700

Now we need to find taxable income
Taxable Income = Accounting Profit + Book Depreciation - Tax Depreciation
Taxable Income = 100,000 + 9000 - 10000
Taxable Income = 99,000
Therefore, Income tax paid = 99,000 * 0.35 = 34,650

Income tax liable = income tax paid + deferred tax liability = 34,650 + 700 = 35,350
alallstar apiccion: Why have you gone from Tax Liability to Asset?

Tax depreciation(10,000)> Book depreciation(9,000)
So, Tax income(99,000)< Accounting income(100,000)
Lower tax income means lower tax payable.
Tax Payable being less than Tax expense means an increase in the liability.

Am I doing something wrong here?
bundy Here's the logic path to answer:
Pretax income is $100,000 x rate .35 = $35000 tax expense

Pretax income + Acct Dep 9000 - Tax Dep 10000 = Taxable income $99,000

Taxable income 99,000 X tax rate .35 = 34,650 taxes payable

This creates a deferred tax effect on IS of $350

Taxes Payable (X) + deferred tax effect on IS $350 = tax expense on IS $35,000

X = 35350
hoyleng appicion is right.! thanks.
sapu i believe its tax liabilty of 350 and not tax asset.
sapu What i understood is:
current year income tax payable= Income tax payable(according to tax code) +closing dtl -opening dtl.
=: 35%of 99000+1050-350=35350
sapu sorry its opening -closing ie. change in deferred tax liablity.
Complete formula for computation is
Income tax payable(under tax code + change in dtl -change in dta.
phani78 The answer seems to be (A). Income taxes payable for 2011 will be $34650 which is derived from the taxable income of $99000. Since the book pre tax income is higher at $100000 which creates a higher tax expense of $ 35000, it would lead to an increase in deferred tax liability of $350 ($35000-$34650). So the liability side would balance as follows: Income tax payable- $34650; Deferred tax liability- $1400 ($1050+$350).
moneyguy [100,000 + (10,000-9,000)] * .35 = $35,350
johntan1979 Wow! Such a long argument!

I think the best thing to do is to first examine the question itself. How in the world can an IRC term "income tax payable" be found on the GAAP balance sheet in the first place???

Should have been "income tax expense" on the balance sheet. Makes sense?

So don't waste your time on a wrong question (stupid whosoever set this question!)
johntan1979 How can DTL be created if taxes payable is more than income tax expense (accounting)?

To have DTL, tax expense must be > taxes payable.
Shaan23 John you're confused. Listen. Tax depreciation is greater then book depreciation so EBT > Taxable Income which is a DTL.

And for everybody else. We do NOT need the previous DTL = 1050 for this question. They shouldnt have wrote Income taxes payable but Income tax expense(Johntan had that correct).

so (100 000 - 99000) * .35 + 100 000*.35 = 35 350
robbiecow Income Tax EXPENSE = (100,000 - 9,000) * 35% = 31,850
Taxes PAYABLE (tax return) = (100,000 - 10,000) * 35% = 31,500
Since EXPENSE > PAYABLE => DTL on the balance sheet of 350

We reconcile income tax expense and taxes payable with the change in DTL. In this case, the DTL increased from zero to 350 during year 1. Therefore, Income Tax EXPENSE for year 1 is:
= 35,000 (100,000*35% )
+ 350 (31,850 - 31,500)

I agree with Shaan23 w/r to the uselessness of including $1,050 as a DTL, unless this was an existing DTL which we needed to.
Kevdharr I think this is my least favorite section so far.
maryprz14 I agree with Khadria
If the tax Dep 2011 was 9,000 and Book Dep was 10,000 then we would have a reversal of DTL. It's because Book income is less than Tax income so we have tax payable greater than tax expense, therefore, REVERSAL OF DTL.
Tax Payable = Tax Expense - DTL
Tax Payable = 35000 - (-350) = 35350
As we see tax payable > tax expense. And it's exactly how Reversal of DTL eats up the total DTL that was created in the first year.
dbedford @ragingrazz: so in 2010 for whatever reason you had a DTL of $1050. In 2011 the IRS said your depreciation should be $10k but your financial statement shows it should be $9k. So what to do is to have them match by realizing $1000 of your $1050 DTL from 2010. Now your books match what the government shows and you pay taxes on the $1000 depreciation difference and the $100000 income
kingirm Agree with dinozav
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