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Chapter 16 Accounting for Income Taxes
True/False Questions
1. A temporary difference originates in one period and reverses, or turns around, in one or more
later periods.
2. Expenditures currently deducted in the tax return but not included with expenses in the income
statement until subsequent years create deferred tax liabilities.
3. A deferred tax asset represents the tax effect of the temporary difference between the financial
carrying value of an asset or liability and its tax basis.
4. Revenues from installment sales of property reported on financial statements in prior years
and currently reported in the tax return create deferred tax assets.
5. Rent collected in advance results in deferred tax assets.
6. MACRS depreciation typically creates deferred tax liabilities early in the life of an asset.
7. An unrealized gain from marking an investment to fair value typically creates a deferred tax
asset.
8. Future taxable amounts result in deferred tax assets.
9. The classification of deferred tax assets is sometimes dependent on when the benefit will be
realized.
10. The basic issue in deciding whether to record a valuation allowance for a deferred tax asset is
if probable taxable income is anticipated to be insufficient to realize the tax benefit.
11. Valuation allowances reduce deferred tax liabilities to the amount that is more likely than not
to be payable in the future.
12. Changes in enacted tax rates that do not become effective in the current period affect deferred
tax accounts only after the new rates take effect.
13. Changes in enacted tax rates only affect income tax expense in the years those changes affect
tax payable.
14. A net operating loss (NOL) carryforward creates a deferred tax liability that should be
classified as current to the extent that the NOL will be recovered in the following year.
15. The tax benefit of a net operating loss carried back two years represents a current receivable
for income tax to be refunded.
16. Deferred tax assets and liabilities typically are classified as current or long term according to
when the underlying temporary difference is expected to reverse.
Multiple Choice Questions
17. GAAP regarding accounting for income taxes requires the following procedure:
a. Computation of deferred tax assets and liabilities based on temporary differences.
b. Computation of deferred income tax based on permanent differences.
c. Computation of income tax expense based on taxable income.
d. Computation of deferred income tax based on temporary and permanent differences.
18. A result of inter-period tax allocation is that:
a. Large fluctuations in a company's tax liability are eliminated.
b. The income tax expense is allocated among the income statement items that caused the
expense.
c. The income tax expense in the income statement is the sum of the income taxes payable
for the year and the changes in deferred tax asset or liability balances for the year.
d. The income tax expense shown in the income statement is equal to the deferred taxes for
the year.
19. Which of the following causes a temporary difference between taxable and pretax accounting
income?
a. Investment expenses incurred to generate tax-exempt income.
b. MACRS used for depreciating equipment.
c. The dividends received deduction.
d. Life insurance proceeds received due to the death of an executive.
20. Which of the following differences between financial accounting and tax accounting
ordinarily creates a deferred tax liability?
a. Interest income on municipal bonds.
b. Proceeds from life insurance received due to death of an executive.
c. Prepaid utilities.
d. None of these answer choices are correct.
21. Which of the following differences between financial accounting and tax accounting
ordinarily creates a deferred tax liability?
a. Depreciation early in the life of an asset.
b. Unrealized losses from recording investments at fair value.
c. Rent collected in advance.
d. None of these answer choices are correct.
22. Which of the following differences between financial accounting and tax accounting
ordinarily creates a deferred tax asset?
a. Depreciation early in the life of an asset.
b. Unrealized gain from recording investments at fair value.
c. Subscriptions collected in advance.
d. None of these answer choices are correct.
23. Which of the following differences between financial accounting and tax accounting
ordinarily creates a deferred tax asset?
a. Unrealized loss from recording inventory impairments.
b. Prepaid expenses.
c. Installment sales for which taxable income recognized when cash is collected.
d. None of these answer choices are correct.
24. Which of the following creates a deferred tax liability?
a. An unrealized loss from recording inventory at lower of cost or market.
b. Accelerated depreciation in the tax return.
c. Estimated warranty expense.
d. Subscriptions collected in advance.
25. Which of the following circumstances creates a future taxable amount?
a. Service fees collected in advance from customers: taxable when received, recognized for
financial reporting when earned.
b. Accrued compensation costs for future payments.
c. Straight-line depreciation for financial reporting and accelerated depreciation for tax
reporting.
d. Investment expenses incurred to obtain tax-exempt income (not tax deductible).
26. Which of the following usually results in an increase in a deferred tax liability?
a. Accrual of estimated operating expenses.
b. Revenue collected in advance.
c. Prepaid operating expenses, currently deductible.
d. All of these answer choices are correct.
Use the following to answer questions 27–29:
Chapter 16 Accounting for Income Taxes
For its first year of operations, Tringali Corporation's reconciliation of pretax accounting
income to taxable income is as follows:
Pretax accounting income
$300,000
Permanent difference
(15,000
)
285,000
Temporary difference-depreciation
(20,000
)
Taxable income
$265,000
Tringali's tax rate is 40%. Assume that no estimated taxes have been paid.
27. What should Tringali report as income tax payable for its first year of operations?
a. $120,000.
b. $114,000.
c. $106,000.
d. $ 8,000.
28.
Pretax accounting income
$300,000
Permanent difference
(15,000
)
285,000
Temporary difference-depreciation
(20,000
)
Taxable income
$265,000
Tringali's tax rate is 40%.
What should Tringali report as its deferred income tax liability as of the end of its first year of
operations?
a. $35,000.
b. $20,000.
c. $14,000.
d. $ 8,000.
29.
Pretax accounting income
$300,000
Permanent difference
(15,000
)
285,000
Temporary difference-depreciation
(20,000
)
Taxable income
$265,000
Tringali's tax rate is 40%.
What should Tringali report as its income tax expense for its first year of operations?
a. $120,000.
b. $114,000.
c. $106,000.
d. $8,000.
Use the following to answer questions 30–32:
Isaac Inc. began operations in January 2016. For certain of its property sales, Isaac recognizes income
in the period of sale for financial reporting purposes. However, for income tax purposes, Isaac
recognizes income when it collects cash from the buyer's installment payments.
In 2016, Isaac had $600 million in sales of this type. Scheduled collections for these sales are as
follows:
2016
$ 60 million
2017
120 million
2018
120 million
2019
150 million
2020
150 million
Chapter 16 Accounting for Income Taxes
$600 million
Assume that Isaac has a 30% income tax rate and that there were no other differences in income for
financial statement and tax purposes.
30. Ignoring operating expenses, what deferred tax liability would Isaac report in its year-end
2016 balance sheet?
a. $18 million
b. $162 million
c. $180 million
d. $540 million
31. Ignoring operating expenses and additional sales in 2017, what deferred tax liability would
Isaac report in its year-end 2017 balance sheet?
a. $ 54 million
b. $144 million
c. $126 million
d. $180 million.
32. Suppose that, in 2017, legislation revised the income tax rates so that Isaac would be taxed in
2018 and beyond at 40%, rather than 30%. Assume that there were no other differences in
income for financial statement and tax purposes. Ignoring operating expenses and additional
sales in 2017, what deferred tax liability would Isaac report in its year-end 2017 balance
sheet?
a. $168 million
b. $144 million
c. $126 million
d. $240 million.
33. In the statement of cash flows, by using the indirect method for determining cash flows from
operating activities, a decrease in deferred tax liabilities is:
a. Added to net income.
b. Subtracted from net income.
c. Ignored.
d. Included under financing activities.
34. Which of the following statements is true as to GAAP regarding accounting for income taxes,
and its use of the asset and liability approach?
a. Considerable flexibility is permitted in the balance sheet classification of deferred tax
amounts.
b. The approach recognizes the time value of money.
c. The approach is consistent with a balance sheet emphasis of U.S. GAAP and the
International Financial Reporting Standards (IFRS).
d. The approach is consistent with cash basis accounting.
Use the following to answer questions 35–39:
The following information relates to Franklin Freightways for its first year of operations (data in
millions of dollars):
Pretax accounting income:
$200
Chapter 16 Accounting for Income Taxes
Pretax accounting income included:
Overweight fines (not deductible for tax purposes)
5
Depreciation expense
70
Depreciation in the tax return using MACRS:
110
The applicable tax rate is 40%. There are no other temporary or permanent differences.
35. Franklin's taxable income ($ in millions) is:
a. $ 40.
b. $165.
c. $110.
d. $160.
36. Franklin Freightways experienced ($ in millions) a current:
a. Tax liability of $66.
b. Tax liability of $36.
c. Tax liability of $70.6.
d. Tax benefit of $10 due to the NOL.
37. Franklin's net income ($ in millions) is:
a. $134.
b. $124.
c. $119.4.
d. $118.
Chapter 16 Accounting for Income Taxes
38. Which of the following must Franklin Freightways disclose related to the income tax expense
reported in the income statement ($ in millions)?
a. Only the current portion of tax expense of $66.
b. Only the total tax expense of $82.
c. Both the current portion of the tax expense of $66 and the deferred portion of the tax
expense of $16.
d. None of these answer choices are correct.
39. Franklin's balance sheet at the end of its first year would report:
a. A deferred tax liability of $16 among noncurrent liabilities.
b. A deferred tax liability of $16 among current liabilities.
c. A deferred tax asset of $16 among noncurrent assets.
d. A deferred tax asset of $16 among current assets.
40. Woody Corp. had taxable income of $8,000 in the current year. The amount of MACRS
depreciation was $3,000, while the amount of depreciation reported in the income statement
was $1,000. Assuming no other differences between tax and accounting income, Woody's
pretax accounting income was:
a. $ 5,000.
b. $ 6,000.
c. $10,000.
d. $11,000.
Chapter 16 Accounting for Income Taxes
41. Alamo Inc. had $300 million in taxable income for the current year. Alamo also had a
decrease in deferred tax assets of $30 million and an increase in deferred tax liabilities of $60
million. The company is subject to a tax rate of 40%. The total income tax expense for the
year was:
a. $390 million.
b. $210 million.
c. $150 million.
d. $180 million.
42. Wayne Co. had an decrease in deferred tax liability of $20 million, a decrease in deferred tax
assets of $10 million, and an increase in tax payable of $100 million. The company is subject
to a tax rate of 40%. The total income tax expense for the year was:
a. $90 million.
b. $100 million.
c. $110 million.
d. $130 million.
Chapter 16 Accounting for Income Taxes
43. Plutonic Inc. had $400 million in taxable income for the current year. Plutonic also had a
decrease in deferred tax assets of $50 million and recognized tax expense of $80 million. The
company is subject to a tax rate of 40%. The change in deferred tax asset was a/an:
a. increase of $30 million.
b. increase of $130 million.
c. decrease of $30 million.
d. decrease of $130 million.
44. During the current year, Stern Company had pretax accounting income of $45 million. Stern's
only temporary difference for the year was rent received for the following year in the amount
of $15 million. Stern's taxable income for the year would be:
a. $30 million.
b. $60 million.
c. $50 million.
d. $45 million.
Chapter 16 Accounting for Income Taxes
Use the following to answer questions 45–47:
Information for Kent Corp. for the year 2016:
Reconciliation of pretax accounting income and taxable income:
Pretax accounting income
$180,000
Permanent differences
(15,000
)
165,000
Temporary difference-depreciation
(12,000
)
Taxable income
$153,000
Cumulative future taxable amounts all from depreciation temporary differences:
As of December 31, 2015 $13,000
As of December 31, 2016 $25,000
The enacted tax rate was 30% for 2015 and thereafter.
45. What should be the balance in Kent's deferred tax liability account as of December 31, 2016?
a. $5,200.
b. $7,500.
c. $25,000.
d. None of these answer choices are correct.
46. What should Kent report as the current portion of its income tax expense in the year 2016?
a. $45,900.
b. $49,500.
c. $54,000.
d. None of these answer choices are correct.
47. What would Kent's income tax expense be in the year 2016?
a. $42,300.
b. $45,900.
c. $49,500.
d. None of these answer choices are correct.
48. Of the following temporary differences, which one ordinarily creates a deferred tax asset?
a. Completed-contract method for long-term construction contracts for tax reporting.
b. Installment sales for tax reporting.
c. Accrued warranty expense.
d. Accelerated depreciation for tax reporting.
49. Using straight-line depreciation for financial reporting purposes and MACRS for tax purposes
in the first year of an asset’s life creates a:
a. Future deductible amount.
b. Permanent difference not requiring inter-period tax allocation.
c. Deferred tax asset.
d. Deferred tax liability.
50. A deferred tax asset represents a:
a. Future income tax benefit.
b. Future cash collection.
c. Future tax refund.
d. Future amount of money to be paid out.
51. Of the following temporary differences, which one ordinarily creates a deferred tax asset?
a. Intangible drilling costs.
b. MACRS depreciation.
c. Rent received in advance.
d. Installment sales.
52. Which of the following differences between financial accounting and tax accounting
ordinarily creates a deferred tax asset?
a. Tax depreciation in excess of book depreciation.
b. Revenue collected in advance
c. The installment sales method for tax purposes.
d. None of these answer choices are correct.
Chapter 16 Accounting for Income Taxes
53. Which of the following creates a deferred tax asset?
a. An unrealized loss from recording investments at fair value.
b. Prepaid insurance.
c. An unrealized gain from recording investments at fair value.
d. Accelerated depreciation in the tax return.
54. Which of the following circumstances creates a future deductible amount?
a. Earning of non-taxable interest on municipal bonds.
b. Sales of property (installment method for tax purposes).
c. Prepaid advertising expense.
d. Accrued warranty expenses.
55. Estimated employee compensation expenses earned during the current period but expected to
be paid in the next period causes:
a. An increase in a deferred tax asset.
b. A decrease in a deferred tax asset.
c. An increase in a deferred tax liability.
d. A decrease in a deferred tax liability.
56. A magazine publisher collects one year in advance for subscription revenue. In the year of
providing the magazines to customers, the company would record:
