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CHAPTER 13 Income Tax Reporting 205
60. At December 31, 2018, the Floyd Company reported a $29,600 deferred tax asset pertaining to a
$80,000 temporary difference which will reverse equally during the next four years; Floyd also reported a
$7,400 deferred tax liability pertaining to a $20,000 temporary difference which will reverse during 2019.
After determining the deferred tax asset and liability on December 31, 2018, Floyd’s management was
informed that the income tax rate for years subsequent to 2018 had been changed to 35%. As a result of
the tax rate change, Floyd’s 2018 income tax expense will
a. increase $1,200.
b. decrease $1,200.
c. decrease $444.
d. increase $444.
61. A company reported income tax payable of $79,500, an increase of $7,900 in its deferred tax asset,
and an increase of $19,750 in deferred tax liability. What is the income tax expense?
a. $91,350
b. $107,150
c. $51,850
d. $67,650
62. Which of the following is not a correct statement regarding deferred tax asset valuation allowance?
a. The determination of whether or not a valuation allowance is necessary is based on subjective
assessment.
b. Profitable companies will never have valuation allowances against deferred tax assets.
c. If a deferred tax asset may not be fully realized in future periods, a valuation allowance is required to
reduce the asset to the amount that is more likely than not to be realized.
d. Companies without a history of profitability may generate negative income tax expense in the year
they first generate a profit if they have a valuation allowance that is reversed in the year of
profitability.
63. If it is more likely than not that future benefits from a deferred tax asset will not be realized in its
entirety, a/an
a. revenue is established.
b. valuation allowance is established.
c. expense allowance is established.
d. equity account is increased.
64. A corporation that incurs a pre-tax operating loss must
a. carryback the loss for tax purposes.
b. carryforward the loss for tax purposes.
c. choose to both carryback and carryforward the loss or to only carryback the loss.
d. choose to both carryback and carryforward the loss or to only carryforward the loss.
65. A corporation that incurs a net operating loss may carry the loss back 2 years and forward
a. 10 years.
b. 12 years.
c. 20 years.
d. 25 years.
Use the following to answer questions 66 – 67:
REFERENCE: Ref. 13_06
During its first three years of operations a company reported pre-tax book income of $1,000,000 in year 1,
($1,800,000) in year 2, and $3,000,000 in year 3. The income tax rate applicable to each of the years was
40%.
Assume that there weren’t any temporary differences and a valuation allowance was not necessary.
[QUESTION]
REFER TO: Ref. 13_06
66. What is the amount of the deferred tax asset reported in the year 2 year-end balance sheet if the
company elected a loss carryback?
a. $720,000.
b. $320,000.
c. $400,000.
d. $0.
[QUESTION]
REFER TO: Ref. 13_06
67. What amount of income tax expense was reported in year 3 if the company elected a loss carryback?
a. $1,200,000
b. $ 880,000
c. $ 480,000
d. $ 400,000
CHAPTER 13 Income Tax Reporting 208
68. Which of the following statements does not accurately describe the accounting for net operating
losses?
a. A firm must assess future profitability when determining the amount of a deferred tax asset.
b. The net operating loss must be carried back two years.
c. The net operating loss may be both carried forward and backward.
d. Prior to 2017, GAAP required the deferred tax asset to be allocated between the current and noncurrent
balance sheet classifications.
69. Increases in deferred tax liability balances represent a potential
a. benefit.
b. deterioration of earnings quality.
c. source of cash flow.
d. source of capital.
70. Analysts can use the deferred tax portion of the income tax note to the financial statements to undo
differences in financial reporting choices across firms and thereby
a. denigrate interfirm comparisons.
b. improve interfirm comparisons.
c. make interfirm comparisons impossible.
d. make intracompany comparisons meaningful.
CHAPTER 13 Income Tax Reporting 209
71. Which of the following statements does not correctly describe required income tax disclosures in the
notes to the financial statements?
a. The statutory tax rate and the effective tax rate are disclosed.
b. The sources that created deferred tax assets and deferred tax liabilities is a required disclosure.
c. The effective tax rate applicable to firms in the same industry is a required disclosure.
d. The expiration date of net operating loss carryforwards must be disclosed.
72. Which of the following does not properly describe the comparison of the effective income tax rate
and the statutory income tax rate?
a. The rates could differ due to the tax jurisdiction that a firm operates in.
b. Permanent differences that cause book income to be higher than taxable income will cause the
effective rate to be lower than the statutory rate.
c. The reconciliation between the rates can reflect information pertaining to a firm’s tax policy decisions.
d. A firm with aggressive tax policies will most likely have an effective tax rate that is much higher than
the statutory rate.
73. Which of the following can’t be assessed by analyzing a company’s deferred tax note to the financial
statements?
a. Earnings quality
b. The effective income tax rate.
c. Future income tax expense.
d. The impact of economic changes on deferred taxes.
74. Which of the following is not a proper description with respect to the financial accounting and
reporting of income taxes?
a. A permanent difference does not create a deferred tax asset or liability.
b. An originating temporary difference will eventually create a reversing temporary difference.
c. A net operating loss carryforward does not have any impact on income tax expense for the year the
loss occurs.
d. Income tax expense changes during the year that future tax rate increases are enacted.
75. Which of the following results in an increase in income tax expense for a particular time period?
a. An increase in the deferred tax asset account during the period.
b. An increase in the income tax rate for future years that was enacted during the time period for a
company reporting a deferred tax asset at the end of the period.
c. A decrease in the deferred liability account during the period.
d. An increase in the income tax rate for future years that was enacted during the time period for a
company reporting a deferred tax liability at the end of the period.
76. Financial accounting and reporting for deferred taxes
a. results in a mismatching of revenues and expenses.
b. does not allow investors to evaluate a firm’s earnings quality.
c. does not require disclosure of a firm’s effective income tax rate.
CHAPTER 13 Income Tax Reporting 211
d. sometimes requires the creation of a liability for unrecognized tax benefits with respect to uncertain
tax positions.
77. A review of the balance sheet of growing companies will likely show
a. an increase in deferred tax liabilities.
b. a decrease in deferred tax liabilities.
c. steady tax liabilities.
d. no deferred tax liabilities.
78. Which of the following statements is not true?
a. Generating deferred tax liabilities always increases cash flows.
b. The use of certain tax accounting methods (such as accelerated depreciation) increases cash flows in
the early years.
c. Tax strategy, regardless of the generation of deferred tax liabilities, affects cash flow.
d. All of these answer choices are true statements.
79. Uncertain tax positions
a. are prohibited under GAAP.
b. are recognized if they might be sustained solely on technical merits.
c. require a two-step process to determine how much benefit should be recognized.
d. are measured as the smallest amount of benefit that is cumulatively greater than 50 percent likely of
being realized.
80. Which of the following is included in the definition of a “tax position”?
a. It applies to only previously filed tax returns.
b. It is reflected in measuring only current income tax payable.
c. It applies only to annual periods.
d. It includes both current and deferred taxes and applies to future tax periods as well as previously filed
tax returns.
81. Klapper Company claimed a tax deduction which was uncertain when it was deducted in 2018 but is
relatively certain of receiving the deduction over a five-year period. Which of the following is not correct
in accounting for the uncertain tax item?
a. As the company will ultimately get 100% of the deduction, no contingency reserve is required.
b. A contingency reserve will be set up at the same amount as the deferred tax asset if the firm is certain
it may claim 100% of the deduction over time.
c. The contingency reserve is reduced each year with the offset to the deferred tax account.
d. Income tax expense in the first year is the current portion of income tax expense minus the increase in
the deferred tax asset.
82. Which of the following statements does not accurately describe disclosures of uncertain tax
positions?
a. Disclosures are not mandatory under U.S. GAAP.
b. Disclosures are generally presented by year.
c. Increases and decreases are disclosed separately.
d. Each uncertain tax position is separately disclosed.
CHAPTER 13 Income Tax Reporting 213
83. An analyst has reviewed Blunt Company’s note disclosures for its deferred taxes and noted a large
increase in Blunt’s deferred tax liability. This increase could be caused by
a. growth in capital expenditures.
b. tax law changes that limit accelerated depreciation.
c. GAAP warranty expenses that exceed tax warranty expenses.
d. shortening the estimated useful lives of its fixed assets.
84. Which of the following is not a correct statement?
a. Increases in deferred tax liability balances may indicate deteriorating earnings quality.
b. Materiality guidelines for reporting changes in deferred tax assets and liabilities are specified in
GAAP.
c. Companies can artificially inflate earnings by using undisclosed estimate changes (e.g., warranty
expense).
d. While financial reporting choices may differ among firms, all firms will select tax policies that
minimize the present value of their tax payments.
85. Which of the following items used for resolving intra-firm comparisons is not generally disclosed?
a. Depreciation methodology – straight line or accelerated.
b. Deferred tax assets related to property plant and equipment.
c. Adjustments to deferred tax assets related to asset sales.
d. Differences between book and tax depreciation.
CHAPTER 13 Income Tax Reporting 214
86. Everwood Co. had net income of $1,000,000 for the year ending December 31, 2018, its first year of
operations. During this time period, Everwood also had a permanent tax difference of $120,000 and its
adjusted pre-tax book income is $1,220,000. Analysts have approximated Everwood’s taxable income at
$735,000 for the year ending December 31, 2018. Which of the following most likely caused the
difference between Everwood’s book and tax income?
a. Accrued warranty expenses not yet deductible on the tax return.
b. A net operating loss carryback.
c. Purchases of long-lived capital assets.
d. Premiums paid on life insurance on key executives where the company is the beneficiary.
87. Which of the following correctly describes the tax rates used under U.S. GAAP and IFRS for
deferred taxes?
a. GAAP uses enacted tax rates while IFRS uses enacted or substantively enacted tax rates.
b. GAAP uses enacted or substantively enacted rates while IFRS uses only enacted tax rates.
c. Both GAAP and IFRS use only enacted tax rates.
d. Both GAAP and IFRS use substantively enacted tax rates.
88. Which of the following is not a difference between IFRS and U.S. GAAP?
a. The use of a valuation allowance which must be separately disclosed.
b. The required reconciliation of statutory and effective tax rates.
c. The use of aggregate tax rates in reconciling statutory and effective tax rates.
d. The required disclosure of the aggregate amount of current and deferred income taxes charged or
credited directly to equity through Other comprehensive income.
CHAPTER 13 Income Tax Reporting 215
89. Key differences between U.S. GAAP and IFRS regarding deferred taxes include all of the following
except
a. reporting of deferred taxes on the balance sheet.
b. uncertain tax positions.
c. reconciliation of statutory and effective tax rates.
d. use of the asset-liability approach.
90. Under IFRS, deferred tax assets
a. are not recognized.
b. require a valuation allowance if it’s more likely than not that the deferred tax asset will not be realized.
c. are recognized only to the extent it is deemed probable that they will be realized.
d. are reported as current or noncurrent based on the expected date of the reversal of the temporary
difference.
91. Under IFRS, deferred taxes
a. are netted into one net current amount or one net noncurrent amount.
b. are always reported as noncurrent.
c. are reported as one net amount per taxable entity.
d. that will be realized are deemed current.
CHAPTER 13 Income Tax Reporting 217
Essay and Computational Questions
92. The Matrix Company began operations as of the beginning of 2018. During 2018, Matrix reported
GAAP (book) income before taxes of $789,500. For income tax purposes, depreciation expense
was $150,000; for GAAP (book) purposes, depreciation expense was $74,000. Matrix accrued
$900,000 of revenue for GAAP (book) purposes during 2018; $600,000 of the accrued revenue
was taxable during 2018. Matrix earned interest of $79,800 from a municipal bond investment
during 2018. Matrix’s marginal income tax rate is 40%. Matrix did not make any income tax
payments during 2018.
Requirements:
1. Determine Matrix’s taxable income for the year ended December 31, 2018.
2. Prepare the 2018 year-end journal entry to record income tax expense.
Answer:
Use the following to answer questions 93 – 94:
REFERENCE 13_06
Smith company records pre-tax book income of $500,000 after accruing $1,000,000 in warranty expense
in its first year of operations. No warranty claims were paid in the first year. The tax rate is 30%.
REFER TO: Ref. 13–06
[QUESTION]
93. Prepare the following:
a. Amount of deferred tax asset
b. Amount of income tax payable
c. Amount of income tax expense
d. Journal entry to record income tax
CHAPTER 13 Income Tax Reporting 218
94. Suppose that prior to completing its first year’s financial statements Smith determines it
is unlikely to earn enough taxable income in future years to realize more than $250,000 of its
deferred tax asset. Prepare an appropriate journal entry to recognize this information.
95. On December 31, 2018, the Lilly Corporation reported a deferred tax liability totaling $12,000,
resulting from depreciation temporary differences pertaining to a depreciable asset purchased during
2018. Lilly uses straight-line depreciation over four years for GAAP (book) purposes; for tax purposes,
the depreciation deduction is 40% of cost during 2018, 30% of cost during 2019, 20% of cost during
2020, and 10% of cost during 2021. During 2019, Lilly expensed $75,000 of warranty costs that will be
deducted for tax purposes in future years. During 2019 Lilly also accrued revenue totaling $150,000
which is taxable in 2020. Lilly’s GAAP (book) income before taxes during 2019 totaled $397,700. The
marginal income tax rate is 40% for all years.
