- 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**

Gifford Co. began operations in 2011 and had an effective tax rate of 30%. Congress enacted new legislation that would increase the company's tax rate to 35% beginning in 2012 and thereafter. Gifford had book income before income taxes of $100,000 for 2011, with tax depreciation exceeding book depreciation by $5,000. What amount of income tax expense will Gifford recognize for 2011?

B. $30,000

C. $28,500

A. $30,250

B. $30,000

C. $28,500

Correct Answer: A

Compute tax expense in two parts in the year an increase is enacted. Tax expense for book income is $30,000 ($100,000 * 30%). Tax expense increases $250 for the rate change on the deferred liability ($5,000 * 5%), for a total tax expense of $30,250.

###
**User Contributed Comments**
21

User |
Comment |
---|---|

kalps |
I do not understand why the tax expense increases becos the higher depreciation will reuslt in lower income for the firm - i am very confused with this answer. |

robkaz |
kalps: Income tax expense is based on book income, not taxable income. So higher tax depreciation did not matter. I myself missed this question because I did not consider tax rate change. Your comments help me to understand explanation. Thanks. |

gjwhite |
tax expense = (taxes payable)+(.35)(current deferred tax liab) -(.35)(current deferred tax assets). Now, taxes payable =(.30)(100k-5k) because tax depreciation was 5k more than financial reporting deprecn. current deferred tax assets=0, and current deferred tax liab.= 5k. so, we have tax expense=(.3)(95k)+(.35)5k)=$30,250. |

danlan |
Same as 0.3*100k+(0.35-0.3)5k=30250 |

HiBunty |
Should not this come in 2012 than in 2011. |

aggabad |
Shouldn't it be B because a tax changes in 2012 (100-5)*.3+ 5*.3=30 |

gth763s |
Tax changes should happen in 2012. |

o123 |
Tax Expense = Tax Payable + kDTL - kDTA [k=change] Without Rate change: 30,000 = 28500 + 1500 With Rate Change: x = 28500 + 1750 x = 30,250 |

Nightsurfer |
Taxes payable reflects today's rate (30%) while the calculation of the deferred liability is done at tomorrow's rate (35%). Income tax expense is the combination of these (payable + liability). |

thud |
Following Nightsurfer's post, 100,000*0.3 (taxes payable) + 5,000*0.35 (DTL) = 31,750. This is what I thought, but apparently is wrong. Why do we only take into account the 5% difference in taxes regarding DTL? Isn't what matters the fact that we still have to pay 0.35% over 5,000, which is total deferred liabilities? |

thekapila |
gjwhite is perfectly right.... tax rate will go on DTL or DTA but will remain same for income tax reporting as long as its not in effective. |

Tomcat82 |
Thud, you're double counting the DTL. at the 20% tax rate and at the 30% tax rate. |

alallstar |
Thud, Your way works, but Taxes payable would be 95,000*.30, not 100,000 * .30 You get 28,500 + 1,750 = 30,250 |

cfaajay |
As per accounting rule the tax should be .3*100000 = 30000, whereas as per tax code it should be .3* ( 100000 + book dep - book dep -5000 )= 28500 Deferred tax asset will be 30000 -28500= 1500 now as tax rate has changed so new tax rate of .35 will be applied to deferred tax liability hence 1500*.35/.3= 1750 total tax expense will be 28500 + 1750=30250 hope this helps. |

gill15 |
Thanks CFAajay....thats a good explanation... |

gill15 |
CFAajay...sweet but its a DTL = 30 0000 - 28500 = 1500 |

gill15 |
Actually there's an easier way. But CFAjay works as well We know tax expense using the old tax rate = .3 * 10000 = 30 000 Now the tax rate has increased so there MUST be an increase in tax expense. We know Taxable income is 95000 and EBT = 100000. Difference between the two is the Expense. Increase in Expense = 50000*(0.05) = 250 Old tax expense = EBT * .3 = 30000 So tax expense = 30250 |

johntan1979 |
Just to confirm: Tax rate changes only affects deferred taxes, not the income? Seems that the 5% rate increase is only applied towards the $5,000. Is that because this is for 2011? And my follow-up question is, for 2012, what is the calculation if income is the same? $100K * 35%? |

Shaan23 |
CFAajay did it best. Main thing to understand. DTA/DTL and Income tax expense is affected by change rate. Taxes payable not affected. Taxes payable = .3*95000 = 28500 DTL = .35 * 5000 = 1750 Income tax X = 28500 + 1750 = 30250 |

dbedford |
On the books you made it as though you paid for $100k @ 30%. You actually only paid 30% on $95k to the IRS so that leaves the $5k difference. The following year you will make that up when rates are at 35% but on the books you already account for the $5k @ 30% since it was part of your $100k you have to account for the extra 5% you will still owe on it so on the books you show a DTL of $5k x .05 the missing 5% |

X212250 |
Really don't have to do any calcs here: Tax Depreciation > Book Depreciation; means there will be a DTL; you will pay then taxes than what is booked; 30,000 is the effective rate and the DTL rate change increases what will be booked. Only option over effective rate is $30,250. |