- CFA Exams
- CFA Level I Exam
- Topic 4. Financial Statement Analysis
- Learning Module 9. Analysis of Income Taxes
- Subject 3. Determining the Tax Base of Assets and Liabilities
CFA Practice Question
Under GAAP, in the first year of an asset's economic life the failure to record the timing difference between straight-line book depreciation expense and accelerated tax depreciation expense results in an understatement of liabilities. True or False?
Correct Answer: True
This timing difference should result in the recording of a deferred tax liability. Therefore, the failure to record the timing difference results in an understatement of liabilities.
User Contributed Comments 6
| User | Comment |
|---|---|
| kalps | In future: Taxable income will be > Financial income and therefore you have deferred tax liability to account for QED |
| mordja | Agree but replace "Financial" with "Pretax" |
| troyes | Right and how exactly do you know Taxable Income will be > Pretax Income if the problem only says there will be a "timing difference", it could be the other way around. |
| fmhp | Accelerated depreciation expense for tax purpose vs straight-line depreciation expense for accounting pupose means taxable income< pretax income which means future taxable income > future pretax income what creates a deferref tax liability. |
| Ifi2703 | Think about it this way - the taxman is always right. So if he thinks my liabilities should be high this year (because he's using accelerated depreciation calculations), my straight-line calculation will understate my liabilities, as far as Mr. Taxman is concerned. This means, as of now, my pre-tax income is therefore higher than what the taxman thinks it is (because i've expensed a smaller depreciation charge against my income) and so next year, for example, i will have to incorporate a higher tax expense amount into my reports. Therefore, as of now, I have a DTL which i wil have to cough up to pay in the future. |
| Shaan23 | Ifi has it right and all of the others are thinking completely wrong. If EBT > Taxable Income we have a DTL right now not a DTA like you guys are saying. Stop thinking future and understand the main point which is DTL NOW. Due to the timing difference not being accounted for we have NOT recorded the DTL and therefor we have an underestimated Liabilty |