CFA Practice Question

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CFA Practice Question

Apple Appliance, Inc. provides warranties for the major appliances it sells. All warranty work for year 2015 sales was done in 2016. Apple has a deferred tax liability as of 12/31/2015 relating to warranties on 2015 sales. True or False?
Correct Answer: False

This is a temporary difference that will cause taxable income to be lower than book income in future periods. In 2015, Apple has a deferred tax asset.

User Contributed Comments 16

User Comment
kalps Taxable income in future periods will be lower (due to warranty payments) and so this creates a deferred tax asset.
gjwhite The terminology above is being used Incorrectly! The situation is: (Pre-tax income) < (Taxable income), because part of the warranty obligation was expensed for financial reporting in 2010 but not for tax reporting. Thus, (tax expense) < (taxes payable) causing a deferred tax asset. Remember: Pre-tax income is a financial reporting term, Taxable income is a tax reporting term.
synner The situation is pre-tax income < taxable income, meaning future taxable income < future future pre-tax income. so pay less in the future. and therefore an deferred tax asset.
achu Put numbers on a paper and you can see, Taxable income is temporarily greater than PI in year one. We pay more tax out of pocket but record a DTA because in year 2 it will reverse itself. Answer is correct.
wundac The whole point was that it is a deferred tax asset and not tax liability. We know that for tax purposes we have to report that
CFAVick How about if you have created a provision for warranties? is the provision also after tax?
prajacti warranty provision is on post tax basis for accounting purpose, but deductible for tax purposes. that's the reason taxable income is lesser than book income; resulting in DTA
jayj001 by far the worst reading i have encountered thus far
johntan1979 I think taxes is just like a woman. You can't understand them but can only memorize your mistakes and try to remember what makes them happy.
2014 I thought I am the only one who is getting taxed by tax ....
Ifi2703 Here's another way to look at this - the company has received payments for these warranties but hasnt yet provided the required service. So, this is unearned revenue. Because they have received this cash already (in 2015), the taxman taxes them as if this extra money from warranty payments is part of their regular income. So, essentially, the actual BS income is less than what the taxman believes it is. In any case, the company pays this higher tax amount in 2015, but will now have a deferred asset for the future (i.e. this tax overpayment is now an asset for them). So, that's why as of the end of 2015, they would have had this overpayment recorded as a DTA.
Hope this helps!
bidisha it helps a lot ifi!
gill15 Thought of it simply. In 2015 Taxes Payable < Tax Expense so initially a DTL and later in 2016 Taxes Payable > Tax Expense so we have a DTA...
gill15 Ignore my last comment

Warrant Expense reduces EBT
2015 EBT < Taxable income
Tax X < Taxes payable

so we have a DTA
Shaan23 Dont fret guys. The placement of this question is NOT ideal. You'll see that.

Carrying Value(Liability) > Tax Base of liability ---> therefor it's a DTA.

I suggest reading the text for this section. Summarizing taxes is difficult thru AN. I've never done taxes but the text made it easy. Took longer then other sections but I suggest it
Inaganti6 Stop making it complicated. You only record warranty expenses on the tax return when it happens. Yet for the accrual statements you expense it regardless of whether you actually did warranty work or not. So the accrual form for 2015 will have lesser profit which means what's taxed is less while the 2015 tax return has no cash charge for warranty work as the actual work was done in 2016. Meaning you took a bigger tax hit on the accrual than cash tax return for 2015 giving you a DTA.
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