CFA Practice Question

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CFA Practice Question

Which of the following is not a factor that will cause the deferred tax liability to grow over time?

I. Growth rate of the firm
II. Specific price level changes
III. General price level changes
Correct Answer: None of them

All of the items can cause the deferred tax liability to increase over time. If price levels increase, the initial amount put into the deferred tax liability will always be more than the amount that is being reversed out. The same pattern will apply if the firm is growing and expanding its depreciable assets.

User Contributed Comments 11

User Comment
examinee My understanding is that as the replacement cost of the asset increases in the future the DTL in the future will more than offset the reversal of the current DTL.
mtcfa So price levels of fixed assets is what they are referring to.
o123 ...but by that logic: wouldnt a decrease in price levels cause the inital amount put into to DTL be less than the amount that will be reveresed out? In which case the DTL will 'reduce' over time?
thud If prices are rising, the present value of your DTL will be lower than its realization and that difference should be recognized as equity, not liability. (Is this right?)
thud Sorry, it's the opposite: realization price will be much lower than book value and such difference becomes equity.
jerylewis I dont understand this question! help! what is the impact of CPI on DTLs?
jerylewis I thing I get it: if prices increase, assets purchased become more expensive and hence assets increase on the B/S. Therefore, DTL are at least stable or increase at the same pace and therefore DTLs are not paid.
thekapila You cant increase asset in B/S its always LCM approach..lower of cost or market.
thekapila Its as simple as : Price increases and firm keep on adding assets. So the liability keep on increasing and least likely to reverse..And DTL keep on increasing.
bundy Price increases means you pay more for depreciable machines...the more you pay the higher the deferred tax liability because of the lower depreciation exp in Book vs Tax
johntan1979 The explanation provided by AnalystNotes in the answer is clear and sufficient for understanding.

Higher price levels --> "New" DTLs > "Old" DTLs

Even though "old" DTL are reversing out, "newer" DTLs with higher initial amounts are replacing them. Hence, DTL account keeps growing.
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