CFA Practice Question

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CFA Practice Question

Clemens Corporation uses the allowance method to recognize bad debts for book purposes and the direct write-off approach, as required, for tax purposes. Assuming Clemens did not write off any bad debts (under GAAP) in their first year, they would recognize ______.

A. a temporary difference as a deferred tax asset
B. a temporary difference as a deferred tax liability
C. no deferred tax asset or liability
Correct Answer: A

The difference between bad debt expense for book purposes and the zero bad debt expense for tax purposes results in a temporary difference. In the future, Clemens will expect to realize the tax benefits from the actual account write-offs. Therefore, they have a deferred tax asset.

User Contributed Comments 10

User Comment
LondonBoy I'm not sure about this? Isn't this the same as a depreciation expense, and therefore a deferred tax liability?
lami It's still the same principle. since the tax officer would not recognise any bad debt, the taxable income would be higher than the accounting income. Thia would bring about a deffered tax asset since the company would be paying more now and would receive little later.
uberstyle isn't it saying they are not writing off any bad debt in the first year to accounting (not taking a reduction in pretax income)? This seems like it would mean pretax income>taxable income which infers deferred tax liabilities. What am I missing?
tonypractice i also felt that no amount was charged against accounting income and
therefore pretax income=taxable income
...meaning no def tax asset or liability
kutta2102 Uberstyle, the 'allowance' method will result in a 'bad debt expense' on financial reporting, reducing the pre-tax income. Since there were no actual write-offs during the year, the taxable income will be higher by an amount equal to the bad debt expense. Therefore, taxable income > pre-tax income which should result in a deferred tax asset.
moneyguy Just when I think I understand the difference between DTL and DTA, I become confused again. They couldn't make this stuff more complicated if they tried!
johntan1979 As much as I hate taxes, I'm starting to understand this crap...

1. Tax reporting uses write-off method but did not write-off anything.
2. Financial reporting uses allowance method, so pretax income is lower and therefore, lower tax expense.
3. Tax expense < tax payable = DTA
Shaan23 Yup - in the same boat as John. Hate it to but am starting to get it.
robbiecow 1. The Allowance method creates a contra-asset called the Allowance for Doubtful Accounts. You would debit Bad Debt Expense and credit Allowance for Doubtful Accounts.

2. As for the direct write-off approach you would debit Bad Debt Expense and credit Accounts Receivable. Note that in order for you to capture something in the Bad Debt Expense under the Direct Write-Off method something MUST be written off.

As johntan1979 points out, you did not write anything off for tax purposes so your Bad Debt Expense under 2 is zero. The difference between this zero Bad Debt Exp. and what was put forth under the allowance method creates a temporary difference.
Freddie33 I just don't get this crap. Ffs
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