SMChap 017

Chapter 17 - FASB ASC Topic 740: Income Taxes
Chapter 17
FASB ASC Topic 740: Income Taxes
SOLUTIONS MANUAL
Discussion Questions
1. (LO 1) Identify some of the reasons why accounting for income taxes is complex.
U.S. tax laws are complex and ambiguous.

A company often prepares its financial statements (Form 10-K) six months or more in
advance of when the company files its corresponding income tax returns.
The rules that apply to accounting for income taxes are not found exclusively in ASC 740
(for example, stock options and business combinations).
2. (LO 1) True or False: ASC 740 applies to all taxes paid by a corporation. Explain.
False. ASC 740 only applies to income taxes paid by a corporation.
3. (LO 1) True or False: ASC 740 is the sole source for the rules that apply to accounting for
income taxes. Explain.
False. With the Accounting Standards Codification, the rules that apply to accounting
for income taxes are found primarily in ASC 740. The codification includes rules
previously found in pronouncements from the Emerging Issues Task Force, opinions from
the former Accounting Principles Board, and pronouncements from the Securities and
Exchange Commission. ASC 740 does not include the income tax accounting rules that
apply to accounting for stock compensation or business combinations. These rules are
found in ASC 718-740 and ASC 805-740.
4. (LO 1) How does the fact that most corporations file their financial statements several months
before they file their income tax returns complicate the income tax provision process?
When a corporation files its financial statements in advance of its federal income tax
return, management must use judgment to estimate the actual tax liability that will result
when the tax return is filed. When the tax return is filed, the corporation must adjust its
balance sheet to reflect the actual taxes payable and make any other adjustments to
reflect the companys true current and deferred tax liabilities. This adjustment often is
referred to as a return-to-provision adjustment or a true-up.
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5. (LO 1) What distinguishes an income tax from other taxes?

The FASB defines an income tax as a tax based on income. This definition excludes
property taxes, excise taxes, sales taxes, and value-added taxes, which are assessed
based on sales or value. A company reports non-income taxes as expenses in the
computation of net income before taxes.
6. (LO 1) Briefly describe the six step process by which a company computes its income tax
provision.
The steps to compute a companys federal income tax provision proceed as follows:
1.
Adjust pre-tax net income for all permanent differences
2.
Identify all temporary differences and tax carryforward amounts
3.
Calculate the current income tax expense or benefit (refund)
4.
Determine the ending balances in the balance sheet deferred tax asset and
liability accounts
5.
Evaluate the need for a valuation allowance for gross deferred tax assets
6.
Calculate the deferred income tax expense or benefit
7. (LO 2) What are the two components of a companys income tax provision? What does each
component represent about a companys income tax provision?
A company computes its current income tax expense or benefit and its deferred income
tax expense or benefit. The current income tax expense or benefit represents the income
taxes payable or refundable in the current year. The deferred income tax expense or
benefit represents the amount necessary to adjust the balance sheet liability or receivable
for future income taxes payable or refundable that result from current and prior year
transactions.
8. (LO 2) True or False: All differences between book and taxable income, both permanent and
temporary, affect a companys effective tax rate. Explain.
False. Permanent differences affect a companys effective tax rate. Temporary
differences affect a companys effective tax rate only when the company adjusts its
balance sheet deferred income tax asset or liability to reflect changes in the enacted tax
rate or for changes in valuation allowances related to deferred tax assets (that is, for
prior period adjustments).
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9. (LO 2) When does a temporary difference resulting from an expense (deduction) create a
taxable temporary difference? A deductible temporary difference?
An expense results in a taxable temporary difference when the tax deduction precedes the
book deduction, creating a future (deferred) tax liability in the period in which the book
expense is recorded. An example is accelerated depreciation elected for tax purposes
and straight line elected for book purposes. An expense results in a deductible
temporary difference when the book deduction precedes the tax deduction, creating a
future (deferred) tax asset in the period in which the tax expense is deducted. An
example is using the accrual method to record bad debts for book purposes and the
charge-off method for tax purposes.
10. (LO 2) When does a temporary difference resulting from income create a taxable temporary
difference? A deductible temporary difference?
Income results in a taxable temporary difference when the income is reported on the
financial statement prior to being reported on the tax return, creating a future (deferred)
tax liability in the period in which the income is reported on the tax return. An example
is use of the installment method for tax purposes and full reporting of the income for
book purposes. Income results in a deductible temporary difference when the income is
reported on the tax return prior to being reported on the financial statement, creating a
future (deferred) tax asset in the period in which the book income is reported. An
example is reporting a prepayment of income on the tax return in the year received and
reporting the income for book purposes in the year the income is earned.
11. (LO 2) Briefly describe what is meant by the asset and liability or balance sheet approach
taken by ASC 740 with respect to computing a corporations deferred tax provision.
Under ASC 740, a companys primary objective is to report its deferred tax assets and
liabilities on the balance sheet at the amounts the company expects to recover or pay
using the enacted tax rate for the period in which the recovery or payment will take
place. The amount necessary to adjust the beginning balance in the deferred tax
accounts to the ending balance becomes the deferred income tax expense or benefit
recorded as part of the income statement income tax provision.
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12. (LO 2) Why are cumulatively favorable temporary differences referred to as taxable
temporary differences?
Initially favorable temporary differences are those differences that cause the current
years taxable income to be less than the corresponding net (book) income. As a result,
the current year tax liability will be less than the provision that relates to net income.
When the difference reverses in a future year, taxable income will exceed net income,
and the current year tax liability will exceed the provision that relates to net income. A
company records this future tax liability (deferred tax liability) in the year in which the
favorable temporary difference arises and decreases (draws down) the tax liability when
the temporary difference reverses in a future period.
13. (LO 2) Why are cumulatively unfavorable temporary differences referred to as deductible
temporary differences?
Initially unfavorable temporary differences are those differences that cause the current
years taxable income to be greater than the corresponding net (book) income. As a
result, the current year tax liability will be greater than the provision that relates to net
income. When the difference reverses in a future year, taxable income will be less than
net income, and the current year tax liability will be less than the provision that relates to
net income. A company records this future tax benefit (deferred tax asset) in the year in
which the unfavorable temporary difference arises and decreases (draws down) the tax
asset when the temporary difference reverses in a future period.
14. ([LO 2) In addition to the current year tax return taxes payable or refundable, what other
transactions can affect a companys current income tax provision?
The current year income taxes payable or refundable also can be affected by 1) tax
refunds or additional tax deficiencies from prior year tax returns that result from an IRS
audit; 2) prior year income tax refunds from current year carrybacks; 3) the portion of
tax benefits from the exercise of nonqualified stock options that were not previously
recorded as temporary differences under ASC 718 or APB 25; or 4) increases in the
unrecognized tax benefit (income taxes payable) under ASC 740.
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15. (LO 2, 4) What is an unrecognized tax benefit and how does it affect a companys current
income tax expense?
An unrecognized tax benefit is the amount of income taxes a company expects to pay as
the result of future income tax return audits by tax authorities. Thought of another way, it
is the amount of income tax benefits the company will have to return in the future as a
result of income tax return audits by tax authorities. Those taxes a company expects to
pay within the next 12 months are classified as current taxes payable on the balance
sheet. Additions to the unrecognized tax benefit are treated as part of the current income
tax expense even if the corporation expects to resolve the uncertain tax position beyond
the next 12 months.
16. (LO 2) True or False: When Congress changes the corporate tax rates, only the current year
book-tax temporary differences are measured using the new rates. Explain.
False. When Congress changes the enacted corporate tax rates, a company must adjust
its total deferred tax asset and deferred tax liability accounts on its balance sheet to
reflect the income tax benefit or expense that will result under the new rate in the future.
The adjustment to the deferred tax accounts will be recorded as an increase or decrease
to the deferred tax expense or benefit and will appear in the reconciliation of the
companys effective tax rate as a prior period adjustment.
17. (LO 2) True or False: All temporary differences have a financial accounting basis. Explain.
False. Not all temporary differences have a financial accounting basis. Net operating
loss and net capital loss carryovers create deferred tax assets but do not have a financial
accounting basis. Organizational expenditures also do not have an accounting basis on
the balance sheet but result in a deferred tax asset if capitalized for tax purposes.
18. (LO 3) What is the purpose behind a valuation allowance as it applies to deferred tax assets?
A valuation allowance operates as a contra account to the deferred tax assets on the
balance sheet. If a company determines that it is more likely than not (a likelihood
greater than 50%) that some portion or all of the deferred tax assets will not be realized
in a future period (that is, reduce future taxable income or future tax liability), the
company must offset the deferred tax assets with a valuation allowance to reflect the
amount it does not expect to realize in the future.
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19. (LO 3) What is the difference between recognition and realization as it applies to the
recording of a deferred tax asset on a balance sheet?
Recognition relates to whether it is probable the company has the right to a future tax
benefit, in which case the company can record the deferred tax asset on the balance
sheet. Realization relates to whether it is more likely than not the company expects to
have sufficient taxable income or tax liability in the future to absorb the future tax
deductions or credits when they are reported on the tax return or before they expire.
20. (LO 3) Briefly describe the four sources of taxable income a company evaluates in
determining if a valuation allowance is necessary.
The four sources of taxable income that are considered in the valuation allowance
process are as follows:
1.
Future reversals of existing favorable (taxable) temporary differences;
2.
Taxable income in prior carryback year(s);
3.
Expected future taxable income exclusive of reversing temporary differences and
carryforwards; and
4.
Taxable income that will result from prudent tax planning strategies.
21. (LO 3) Which of the four sources of taxable income are considered objective and which are
considered subjective? Which of these sources generally receives the most weight in analyzing
whether a valuation allowance is necessary?
The objective sources are future reversals of existing favorable (taxable) temporary
differences and taxable income in prior carryback years. The subjective sources are
expected future taxable income exclusive of reversing taxable temporary differences and
carryforwards and taxable income that will result from tax planning strategies.
Objective sources of taxable income generally receive more weight when analyzing
whether a valuation allowance is necessary.
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22. (LO 3) What are the elements that define a tax planning strategy as it applies to determining
if a valuation allowance is necessary? Provide an example where a tax planning strategy may be
necessary to avoid recording a valuation allowance.
ASC 740 defines a tax planning strategy as an action that is 1) prudent and feasible, 2) is
one that is not in the ordinary course of business but which a company would take to
prevent an operating loss or tax credit carryforward from expiring unused, and 3) would
result in realization of the deferred tax assets. An example of a tax planning strategy
might be a companys willingness to sell a parcel of land held for investment to create a
capital gain that could be used to keep a net capital loss carryover from expiring unused.
A company would have to rely on a tax planning strategy to avoid recording a valuation
allowance when the other three sources of taxable income do not provide sufficient
taxable income to absorb the recorded deferred tax assets.
23. (LO 3) When does a company remove a valuation allowance from its balance sheet?
A company removes a valuation allowance from its balance sheet when it determines that
it is more-likely-than-not that, based on all available evidence, a deferred tax asset will
be realized (that is, the tax benefit will be received) in a future period.
24. (LO 3) What is a companys book equivalent of taxable income and how does this
computation enter into the income tax provision process?
A company computes its book equivalent of taxable income by adjusting pretax net
income from continuing operations for permanent differences. Multiplying the book
equivalent of taxable income by the applicable tax rate provides a back-of-the
envelope computation of the companys total income tax provision, assuming there is no
change in the companys applicable tax rate during the period or other changes related
to a prior period (for example, an adjustment of a valuation allowance).
25. (LO 4) What motivated the FASB to issue FIN 48?
The FASB issued FIN 48 (now codified in ASC 740-10) because it was concerned that
there was diversity in practice in the way in which companies computed their income
tax contingency reserve under FAS 5.
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26. (LO 4) Briefly describe the two step process a company must undertake when it evaluates
whether it can record the tax benefit from an uncertain tax position under ASC 740.
ASC 740-10 applies a two-step process to evaluating tax positions. ASC 740 refers to the
first step as recognition. A company must determine whether it is more likely than not (a
greater than 50% probability) that a tax position will be sustained on examination by the
IRS or other taxing authority, including resolution of any appeals at the court of last
resort (the Supreme Court in the United States), based on the technical merits of the
position.
The second step is referred to as measurement. If the tax position meets the more-likelythan-not threshold (a subjective determination), the company must determine the amount
of the benefit to record in the financial statements. The company records the largest
amount of the benefit, as calculated on a cumulative probability basis, that is morelikely-than-not to be realized on the ultimate settlement of the tax position. The portion
not recognized is referred to as an unrecognized tax benefit and is recorded as an
increase in income taxes payable on the balance sheet.
27. (LO 4) Distinguish between recognition and measurement as they relate to the computation
of unrecognized tax benefits under ASC 740.
Recognition is the process of determining whether the company can record some portion
or all of the tax benefit from the tax position on its financial statements. Measurement is
the process of determining the amount of the tax benefit that can be recorded on the
financial statements.
28. (LO 4) What is a tax position as it relates to the application of ASC 740 to uncertain tax
positions?
ASC 740-10 defines a tax position as any issue dealing with income taxes. ASC 740
pertains to tax positions taken on a current or previously filed tax return or a tax position
that will be taken on a future tax return that is reflected in the financial statements as a
deferred tax asset or liability. A tax position also relates to tax returns that the company
has not filed in a tax jurisdiction but could be required to file in the future on audit.
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29. (LO 4) True or False: A company determines its unrecognized tax benefits with respect to a
transaction only at the time the transaction takes place; subsequent events are ignored. Explain.
False. A company must reassess its balance in its unrecognized tax benefit account when
subsequent events occur (for example, the issuance of regulations, rulings, court
opinions) that might change the companys assessment of whether a tax position will be
sustained on audit and litigation. As facts and circumstances change, a company must
reevaluate the tax benefit amount they expect to realize in the future.
30. (LO 4) True or False: ASC 740 requires that a company treat potential interest and penalties
related to an unrecognized tax benefit as part of its income tax provision. Explain.
False. ASC 740-10 allows a company to treat potential interest and penalties related to
an unrecognized tax benefit as part of its income tax provision or as expenses deducted in
the computation of its pre-tax income or loss from continuing operations. ASC 740
requires that the company apply its election consistently from period to period and
disclose how it is treating the interest and penalties in its financial statements in a
footnote to the financial statements (usually in the Income Taxes note). The liability
related to interest and penalties is not included in the liability related to unrecognized tax
benefits on the balance sheet, however.
31. (LO 4) Where on the balance sheet does a company report its unrecognized tax benefits?
A company reports its unrecognized tax benefits as part of its income taxes payable or
some other liability on the balance sheet. The additional tax that the company expects to
pay in the next 12 months is classified as current income taxes payable. The tax the
company expects to pay beyond the next 12 months is classified as long-term income
taxes payable.
32. (LO 4) Why did many companies oppose FIN 48 when it was first proposed?
Opponents of FIN 48 worried that the FIN 48 disclosures would provide a roadmap to
the IRS to a companys uncertain tax positions. The aggregate reporting of uncertain tax
positions has provided the IRS with less information than it may have expected, which led
the Treasury to create new Schedule UTP, on which a company is required to list its
uncertain tax positions taken on its financial statements.
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33. (LO 5) How does a company determine if a deferred tax asset or liability should be classified
as current or noncurrent on its balance sheet?
A company classifies its deferred tax assets and liabilities based on the classification of
the asset or liability to which the deferred tax account relates. Deferred tax liabilities
related to a long-term asset (for example, depreciation of a fixed asset) are classified as
noncurrent because the related asset is classified as noncurrent on the balance sheet. A
deferred tax asset related to uncollectible accounts receivable would be classified as a
current asset because accounts receivable is treated as a current asset. Deferred tax
liabilities and assets not related to a specific asset (for example, a net operating loss
carryover or organizational expenditures capitalized for tax purposes) are classified
based on the expected reversal date of the temporary difference.
34. (LO 5) Under what conditions can a company net its current deferred tax assets with its
current deferred tax liabilities on the balance sheet?
ASC 740 permits netting of current deferred tax assets and liabilities if they are
attributable to the same tax jurisdiction or relate to the same components of the
enterprise (for example, a subsidiary that is part of the consolidated financial statements
and part of the consolidated income tax return). The same netting rule applies to
noncurrent deferred tax assets and liabilities as well.
35. (LO 5) True or False: A publicly traded company must disclose all of the components of its
deferred tax assets and liabilities in a footnote to the financial statements. Explain.
False. ASC 740 states that a publicly traded company should disclose the approximate
tax effect of each type of temporary difference and carryforward that gives rise to a
significant portion of net deferred tax liabilities and deferred tax assets. A privately
held company only needs to disclose the types of significant temporary differences
without disclosing the tax effects of each type. ASC 740 does not define the term
significant, although the SEC requires a publicly traded company to disclose separately
the components of its total deferred tax assets and liabilities that are 5% or more of the
total balance.
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36. (LO 5) What is a companys hypothetical income tax provision and what is its importance in
a companys disclosure of its income tax provision in the tax footnote?
A companys hypothetical income tax provision is the income tax provision or benefit that
would result from applying the companys U.S. statutory tax rate (34% or 35%) to its
pretax income or loss from continuing operations. The hypothetical income tax provision
is the amount that is reconciled with the companys actual income tax provision or benefit
in the effective tax rate reconciliation component of the companys income taxes note to
the financial statements.
37. (LO 5) Briefly describe the difference between a companys effective tax rate, cash tax rate,
and structural tax rate.
The effective tax rate is the companys total income tax expense or benefit divided by the
companys pre-tax net income or loss from continuing operations. The effective tax rate
often serves as a benchmark for companies in the same industry. A companys cash tax
rate is the effective tax rate taking into account only taxes actually paid or refunded
during the year. Taxes paid or refunded usually is reported in the companys Statement of
Cash Flows. A companys structural tax rate is the effective tax rate adjusted for onetime (discrete) and non-recurring book-tax differences. It is usually interpreted as the
companys sustainable effective tax rate from operations.
Problems
38. (LO 1) Which of the following taxes is not accounted for under ASC 740?
a.
Income taxes paid to the U.S. government
b.
Income taxes paid to the French government
c.
Income taxes paid to the city of Detroit
d.
Property taxes paid to the city of Detroit
e.
All of the above taxes are accounted for under ASC 740
d. Property taxes paid to the city of Detroit are not income taxes because they are
assessed based on value and not income.
39. (LO 1) Which of the following organizations can issue rules that govern accounting for
income taxes?
a.
FASB
b.
SEC
c.
IRS
d.
a and b above
e.
All of the above organizations
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d. Both the FASB and SEC can issue rules that govern accounting for income taxes.
Congress also can issue rules that govern accounting for income taxes, but the IRS is
restricted to writing rules and procedures related to the federal income tax.
40. ([LO 1) Find the paragraph(s) in ASC 740 that deal with the following items (you can access
ASC 740 on the FASB website at http://www.fasb.org, and clicking on View the Codification.
You will need a password from your instructor.
a.
The objectives and basic principles that underlie ASC 740
b.
Examples of book-tax differences that create temporary differences
c.
The definition of a tax planning strategy
d.
Examples of positive evidence in the valuation allowance process
e.
Rules relating to financial statement disclosure
a. ASC 740: 740-10-10-1
b. 740-10-25-20
c. 740-10-30-19
d. 740-10-30-22
e. 740-10-50
41. (LO 2) Woodward Corporation reported pre-tax book income of $1,000,000. Included in the
computation were favorable temporary differences of $200,000, unfavorable temporary
differences of $50,000, and favorable permanent differences of $100,000. Assuming a tax rate of
34%, compute the companys current income tax expense or benefit.
$1,000,000
(200,000)
50,000
(100,000)
750,000
34%
$255,000
Pre-tax book income

Favorable temporary differences
Unfavorable temporary differences
Favorable permanent differences
Taxable income
34%
Current income tax expense
42. (LO 2) Cass Corporation reported pre-tax book income of $10,000,000. During the current
year, the reserve for bad debts increased by $100,000. In addition, tax depreciation exceeded
book depreciation by $200,000. Cass Corporation sold a fixed asset and reported book gain of
$50,000 and tax gain of $75,000. Finally, the company received $250,000 of tax-exempt life
insurance proceeds from the death of one of its officers. Assuming a tax rate of 34%, compute
the companys current income tax expense or benefit.
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$10,000,000
100,000
(200,000)
25,000
(250,000)
$9,675,000
34%
$3,289,500
Pre-tax book income

Increase in bad debt reserve
Excess tax depreciation
Excess tax over book gain
Tax-exempt life insurance proceeds
Taxable income
34%
Current income tax expense
43. (LO 2) Grand Corporation reported pre-tax book income of $600,000. Tax depreciation
exceeded book depreciation by $400,000. In addition, the company received $300,000 of taxexempt municipal bond interest. The companys prior year tax return showed taxable income of
$50,000. Assuming a tax rate of 34%, compute the companys current income tax expense or
benefit.
Pre-tax book income
Tax-exempt interest income
Net operating loss
$600,000
(400,000)
(300,000)
$(100,000)
NOL carryback to prior year

34%
Current income tax benefit
$50,000
34%
$17,000
The remaining $50,000 NOL carryover will be recorded as a deferred tax asset (benefit)
of $17,000.
44. (LO 2) Chandler Corporation reported pre-tax book income of $2,000,000. Tax depreciation
exceeded book depreciation by $500,000. During the year the Company capitalized $250,000
into ending inventory under 263A. Capitalized inventory costs of $150,000 in beginning
inventory were deducted as part of cost of goods sold on the tax return. Assuming a tax rate of
34%, compute the companys taxes payable or refundable.
$2,000,000
(500,000)
100,000
$1,600,000
34%
$544,000
Pre-tax book income

Increase in capitalized inventory costs
Taxable income
34%
Current income taxes payable
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45. (LO 2) Davison Company determined that the book basis of its office building exceeded the
tax basis by $800,000. This basis difference is properly characterized as:
a.
Permanent difference
b.
Taxable temporary difference
c.
Deductible temporary difference
d.
Favorable book-tax difference
e.
Both b and d above are correct
e. Taxable temporary difference and favorable book-tax difference. Future taxable
income will increase by $800,000 compared to future book income as the excess book
basis is recovered, resulting in a future tax payable.
46. (LO 2) Abbot Company determined that the book basis of its allowance for bad debts is
$100,000. There is no corresponding tax basis in this account. The basis difference is properly
characterized as:
a.
Permanent difference
b.
Taxable temporary difference
c.
Deductible temporary difference
d.
Favorable book-tax difference
e.
Both b and d above are correct
c. Deductible temporary difference. Future taxable income will decrease by $100,000
compared to future book income as the bad debts are charged off, resulting in a future tax
benefit.
47. (LO 2) Which of the following items is not a temporary book-tax basis difference?
a.
Warranty reserve accruals
b.
Accelerated depreciation
c.
Capitalized inventory costs under 263A
d.
Nondeductible stock option compensation from exercising an ISO
e.
All of the above are temporary differences
d. Nondeductible stock option compensation from exercising an ISO (incentive stock
option). A company does not receive a tax deduction when an employee exercises an
incentive stock option, making the book stock compensation deduction a permanent
difference.
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48. (LO 2) Which of the following book-tax differences does not create a favorable temporary
book-tax basis difference?
a.
Tax depreciation for the period exceeds book depreciation
b.
Bad debts charged off in the current period exceed the bad debts accrued
in the current period
c.
Inventory costs capitalized under 263A deducted as part of current year
tax cost of goods sold are less than the inventory costs capitalized in ending
inventory
d.
Vacation pay accrued for tax purposes in a prior period is deducted in the
current period
e.
All of the above create a favorable temporary book/tax temporary difference
c. Inventory costs capitalized under 263A deducted as part of current year tax cost of
goods sold are less than the inventory costs capitalized in ending inventory. In this case,
book income would exceed taxable income, creating an unfavorable book-tax difference.
49. (LO 2) Lodge, Inc. reported pre-tax book income of $5,000,000. During the year, the
company increased its reserve for warranties by $200,000. The company deducted $50,000 on
its tax return related to warranty payments made during the year. What is the impact on taxable
income compared to pre-tax book income of the book-tax difference that results from these two
events?
a.
Favorable (decreases taxable income)
b.
Unfavorable (increases taxable income)
c.
Neutral (no impact on taxable income)
b Unfavorable (increases taxable income). Book income would be $150,000 less than
taxable income in the current year.
50. (LO 2) Which of the following book-tax basis differences results in a deductible temporary
difference?
a.
Book basis of a fixed asset exceeds its tax basis
b.
Book basis of a pension-related liability exceeds its tax basis
c.
Prepayment of income included on the tax return but not on the income
statement (the transaction is recorded as a liability on the balance sheet)
d.
All of the above result in a deductible temporary difference
e.
Both b and c result in a deductible temporary difference
e. The future payment of the accrued pension liability and the future recording of
previously recorded taxable income will result in future taxable income being less than
book income, resulting in a future tax benefit.
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51. (LO 2) Shaw Corporation reported pre-tax book income of $1,000,000. Included in the
differences of $50,000, and favorable permanent differences of $100,000. Assuming a tax rate of
34%, compute the companys deferred income tax expense or benefit.
Favorable temporary differences
Net increase in favorable temporary diff.
34%
Net increase in deferred income tax liability
$(200,000)
50,000
$(150,000)
34%
$ (51,000)
The net increase in the deferred income tax liability is recorded as the companys
deferred tax expense in the current year. Permanent differences do not affect the deferred
income tax provision.
52. (LO 2) Shaw, Inc. reported pre-tax book income of $10,000,000. During the current year,
the reserve for bad debts increased by $100,000. In addition, tax depreciation exceeded book
depreciation by $200,000. Shaw, Inc. sold a fixed asset and reported book gain of $50,000 and
tax gain of $75,000. Finally, the company received $250,000 of tax-exempt life insurance
proceeds from the death of one of its officers. Assuming a tax rate of 34%, compute the
companys deferred income tax expense or benefit.
Increase in bad debt reserve
Excess tax gain
34%
$100,000
(200,000)
25,000
$ (75,000)
34%
$ (25,500)
deferred tax expense in the current year. Permanent differences do not affect the deferred
tax provision.
53. (LO 2) Harrison Corporation reported pre-tax book income of $600,000. Tax depreciation
exceeded book depreciation by $400,000. In addition, the company received $300,000 of taxexempt municipal bond interest. The companys prior year tax return showed taxable income of
$50,000. Assuming a tax rate of 34%, compute the companys deferred income tax expense or
benefit.
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$600,000
(400,000)
(300,000)
$(100,000)
Pre-tax book income

Net operating loss
$50,000
34%
$17,000
NOL carryback to prior year

34%
Current income tax refundable
NOL carryover to 2014
34%
(400,000)
50,000
$(350,000)
34%
$(119,000)
deferred tax expense in the current year. This assumes the company does not record a
valuation against the deferred tax asset created by the NOL carryover. Permanent
differences do not affect the deferred tax provision.
54. (LO 2) Identify the following items as creating a temporary difference, permanent difference,
or no difference.
Item
Temporary
Permanent
No
Difference
Difference
Difference
Reserve for warranties
Accrued pension liability
Goodwill not amortized for tax purposes but

subject to impairment under ASC 350
Meal and entertainment expenses
Life insurance proceeds
Net capital loss carryover
Nondeductible fines and penalties
Accrued vacation pay liability paid within the first

2 months of the next tax year
17-17
55. (LO 2) Which of the following items is not a permanent book/tax difference?
a.
b.
Tax-exempt insurance proceeds
c.
Domestic production activities deduction
d.
Non-deductible meals and entertainment expense
e.
First-year expensing under 179
e. First year expensing under 179. First year expensing will eventually be recovered as
book depreciation.
56. (LO 2) Ann Corporation reported pre-tax book income of $1,000,000. Included in the
differences of $50,000, and favorable permanent differences of $100,000. Compute the
Companys book equivalent of taxable income. Use this number to compute the Companys total
income tax provision or benefit, assuming a tax rate of 34%.
$1,000,000
(100,000)
900,000
34%
$306,000
Pre-tax book income

Favorable permanent differences
Book equivalent of taxable income
34%
Total income tax provision
Book equivalent of taxable income takes into account only permanent differences.
57. (LO 2) Burcham Corporation reported pre-tax book income of $600,000. Tax depreciation
exceeded book depreciation by $400,000. In addition, the Company received $300,000 of taxexempt municipal bond interest. The Companys prior year tax return showed taxable income of
$50,000. Compute the Companys book equivalent of taxable income. Use this number to
compute the Companys total income tax provision or benefit, assuming a tax rate of 34%.
$600,000
(300,000)
300,000
34%
$102,000
Pre-tax book income

Tax-exempt interest
Book equivalent of taxable income
34%
Total income tax provision
Book equivalent of taxable income takes into account only permanent differences.
17-18
58. (LO 3) Adams Corporation has total deferred tax assets of $3,000,000 at year-end.
Management is assessing whether a valuation allowance must be recorded against some or all of
the deferred tax assets. What level of assurance must management have, based on the weight of
available evidence, that some or all of the deferred tax assets will not be realized before a
valuation allowance is required?
a.
Probable
b.
More likely than not
c.
Realistic possibility
d.
Reasonable
e.
More than remote
b.
59. (LO 3) Which of the following evidence would not be considered positive in determining
whether Adams Corporation needs to record a valuation allowance for some or all of its deferred
tax assets?
a.
The Company forecasts future taxable income because of its backlog of orders
b.
The Company has unfavorable temporary differences that will create
future .taxable income when they reverse.
c.
The Company has tax planning strategies that it can implement to create
future taxable income.
d.
The Company has cumulative net income over the current and prior two
years.
e.
The Company had a net operating loss carryover expire in the current year.
e. The Company had a net operating loss carryover expire in the current year. ASC 740
lists the expiration of tax carryovers as a source of negative evidence.
60. (LO 3) As of the beginning of the year, Gratiot Company recorded a valuation allowance of
$200,000 against its deferred tax assets of $1,000,000. The valuation allowance relates to a net
operating loss carryover from the prior year. During the year, management concludes that the
valuation allowance is no longer necessary because it forecasts sufficient taxable income to
absorb the NOL carryover. What is the impact of managements reversal of the valuation
allowance on the companys effective tax rate?
a.
Increases the ETR
b.
Decreases the ETR
c.
No impact on the ETR
b. Decreases the ETR. Removing the valuation allowance creates an increase in the
companys income tax benefit, which is treated as a prior period adjustment and causes
the effective tax rate to decrease.
17-19
61. (LO 3) Which of the following evidence would be considered negative in determining
whether Gratiot Corporation needs to record a valuation allowance for some or all of its deferred
tax assets?
a.
The company forecasts future taxable income because of its backlog of orders.
b.
The company has a cumulative net loss over the current and prior two
years.
c.
The company has unfavorable temporary differences that will create future
taxable income when they reverse.
d.
The company had a net operating loss carryover expire in the current year.
e.
Both b and d constitute negative evidence in assessing the need for a
valuation allowance.
e. Both b and d constitute negative evidence in assessing the need for a valuation
allowance. ASC 740 states that cumulative book losses constitute a source of negative
evidence, as does the expiration of a net operating loss carryover.
62. (LO 3) Saginaw, Inc. completed its first year of operations with a pre-tax loss of $500,000.
The tax return showed a net operating loss of $600,000, which the Company will carry forward.
The $100,000 book-tax difference results from excess tax depreciation over book depreciation.
Management has determined that they should record a valuation allowance equal to the net
deferred tax asset. Assuming the current tax expense is zero, prepare the journal entries to record
the deferred tax provision and the valuation allowance.
Deferred tax asset*
Deferred tax benefit
*$600,000 34%
Deferred tax expense
Deferred tax liability*
*$100,000 34%
Deferred tax benefit*
Valuation allowance
*$($600,000 - $100,000) 34%
204,000
204,000
34,000
34,000
170,000
170,000
63. (LO3) Access Ford Motor Companys Annual Report for 2011 from the companys website
(www.ford.com). What amount of valuation allowance against its deferred tax assets did the
company release in 2011? What reasons did management give for releasing the valuation
allowance? (Hint: Read Managements Discussion and Analysis and the Income Taxes
footnote.) What impact, if any, did release of the valuation allowance have on the companys
effective tax rate for 2011? Why did the valuation allowance release affect (not affect) the
companys ETR?
Ford Motor Co. reduced its valuation allowance from $15,664 million in 2010 to $1,545
million in 2011.
17-20
Management gave the following reasons for reducing the valuation allowance in its
Discussion and Analysis:
17-21
At December 31, 2010, our valuation allowance was $15.7 billion, leaving net deferred
tax assets of about $900 million on our balance sheet. Prior to year-end 2011, the pattern of
objectively-measured negative evidence of recent financial reporting losses outweighed the
positive evidence of our growing profitability, despite the tangible progress we were making in
implementing our One Ford plan.
By the end of 2011, our U.S. operations had returned to a position of cumulative profits for
the most recent three-year period. We concluded that this record of cumulative profitability in
recent years, our ten consecutive quarters of pre-tax operating profits, our successful completion
of labor negotiations with the UAW, and our business plan showing continued profitability,
provided assurance that our future tax benefits more likely than not will be realized. Accordingly,
at year-end 2011, we released almost all of our valuation allowance against net deferred tax
assets for entities in the United States, Canada, and Spain, resulting in a $12.4 billion benefit in
our provision for income taxes.
The reduction in the valuation allowance reduced Fords effective tax rate by 172.3
percentage points! This percentage point decrease is computed by dividing the reduction in the
valuation allowance of $14,119 million by pretax income of $8,181 million. The reduction in the
valuation allowance impacts the current period effective tax rate because it is a prior period
adjustment that runs through continuing operations for income tax accounting purposes.
64. (LO 4) Montcalm Corporation has total deferred tax assets of $3,000,000 at year-end. Of
that amount, $1,000,000 results from the current expensing of an expenditure that the IRS might
assert must be capitalized on audit. Management is trying to determine if it should not recognize
the deferred tax asset related to this item under ASC 740. What confidence level must
management have that the item will be sustained on audit before it can recognize any portion of
the deferred tax asset under ASC 740?
a.
Probable
b.
c.
Realistic possibility
d.
Reasonable
e.
More than remote
b. More likely than not
17-22
65. (LO 4) Which of the following statements about uncertain tax positions (UTP) is correct?
a.
UTP applies only to tax positions accounted for under ASC 740 taken on a
filed tax return.
b.
UTP applies to all tax positions accounted for under ASC 740, regardless
of whether the item is taken on a filed tax return.
c.
UTP deals with both the recognition and realization of deferred tax assets.
d.
If a tax position meets the more likely than not standard, the entire amount
of the deferred tax asset or current tax benefit related to the tax position can be
recognized under ASC 740.
e.
Statements b, c, and d are correct.
b. UTP applies to all tax positions accounted for under ASC 740, regardless of whether
the item is taken on a filed tax return.
66. (LO 4) Cadillac Square Corporation determined that $1,000,000 of its domestic production
activities deduction on its current year tax return was uncertain, but that it was more likely than
not to be sustained on audit. Management made the following assessment of the Companys
potential tax benefit from the deduction and its probability of occurring.
Potential Estimated
Benefit (000s)
$340,000
272,000
170,000
0
Individual Probability
of Occurring (%)
40
25
20
15
Cumulative Probability
of Occurring
40
65
85
100
What amount of the tax benefit related to the uncertain tax position from the DPAD can Cadillac
Square Corporation recognize in calculating its income tax provision in the current year?
$272,000, the amount that has a cumulative probability of more than 50% of occurring.
Cadillac Square Corporation would record an increase in its income taxes payable
(income tax expense) of $68,000, the difference between the full benefit received on the
tax return and the expected benefit to be received after audit by the IRS.
67. (LO 4) How would your answer to Question 66 change if management determined that there
was only a 50/50 chance any portion of the $1,000,000 domestic production activity deduction
(DPAD) would be sustained on audit?
No amount of the tax benefit from the deduction could be recognized. The recognition
threshold has not been met (more likely than not), and therefore, the measurement step is
not taken. Cadillac Square Corporation would record an increase in its income taxes
payable (income tax expense) of $340,000, the full benefit received on the tax return.
17-23
68. (LO 4) As part of its UTP assessment, Penobscot Company records interest and penalties
related to its tax contingency amount of $500,000. Which of the following statements about
recording this amount is most correct?
a.
Penobscot must include the amount in its income tax provision
b.
Penobscot must record the amount separate from its income tax provision
c.
Penobscot can elect to allocate a portion of the amount to both its income
tax provision and its general and administrative expenses provided the company
discloses which option it chose
d.
Penobscot can elect to record the entire amount as part of its income tax
provision or separate from its income tax provision, provided the company
discloses which option it chose
e.
Statements c and d are both correct
d. Penobscot can elect to record the entire amount as part of its income tax provision or
separate from its income tax provision as a pre-tax operating expense, provided the
Company discloses which option it is using.
69. (LO5) What was IBMs accounting effective tax rate for 2011? What items caused the
companys accounting effective tax rate to differ from the hypothetical tax rate of 35%? What
was the companys cash effective tax rate for 2011? What factors cause a companys cash tax
rate to differ from its accounting effective tax rate? You can access IBMs annual report for 2011
at http://www.ibm.com.
IBMs accounting effective tax rate for 2011 was 24.5% ($5,148/$21,003).
IBM reports that its effective tax rate decreased 10 percentage points from the foreign
tax rate differential, increased 2 percentage points from state and local taxes, and
decreased 2 percentage points by other.
IBMs cash effective tax rate for 2011 was 19.8% ($4,168/$21,003).
The cash effective tax rate can differ from the accounting effective tax rate because of
additional taxes or refunds received from audits of prior year tax returns and from the tax
benefits related to the exercise of nonqualified stock options.
17-24
70. (LO 5) Beacon Corporation recorded the following deferred tax assets and liabilities:
Current deferred tax assets
Current deferred tax liabilities
Non-current deferred tax assets
Non-current deferred tax liabilities
Net deferred tax liabilities
$650,000
(400,000)
1,000,000
(2,500,000)
$(1,250,000)
All of the deferred tax accounts relate to temporary differences that arose as a result of the
companys U.S. operations. Which of the following statements describes how Beacon should
disclose these accounts on its balance sheet?
a.
Beacon reports a net deferred tax liability of $1,250,000 on its balance
sheet
b.
Beacon nets the deferred tax assets and the deferred tax liabilities and
reports a net deferred tax asset of $1,650,000 and a net deferred tax liability of
$2,900,000 on its balance sheet.
c.
Beacon can elect to net the current deferred tax accounts and the noncurrent tax accounts and report a net current deferred tax asset of $250,000 and a
net deferred tax liability of $1,500,000 on its balance sheet.
d.
Beacon is required to net the current deferred tax accounts and the noncurrent tax accounts and report a net current deferred tax asset of $250,000 and a
net deferred tax liability of $1,500,000 on its balance sheet.
d. Beacon is required to net the current deferred tax accounts and the non-current tax
accounts and report a net current deferred tax asset of $250,000 and a net deferred tax
liability of $1,500,000 on its balance sheet. The netting is required because the deferred
tax accounts all arose in the same tax jurisdiction (ASC 740-10-45-6).
71. (LO 5) ASC requires a company to disclose those components of its deferred tax assets and
liabilities that are considered
a.
Relevant
b.
Significant
c.
Important
d.
Major
b. Significant
72. (LO 5) Which of the following temporary differences creates a current deferred tax asset?
a.
Allowance for bad debts
b.
Goodwill amortization
c.
Accumulated depreciation
d.
Inventory capitalization under 263A
e.
Both a and d create a current deferred tax asset
17-25
e. Both a and d create a current deferred tax asset. Deferred tax accounts are classified
based on the balance sheet classification of the item to which they relate. Accounts
receivable and inventory are both classified as current assets.
17-26
73. (LO 5) Which formula represents the calculation of a companys effective tax rate?
a.
Income taxes paid / Taxable income
b.
Income taxes paid / Pre-tax income from continuing operations
c.
Income tax provision / Taxable income
d.
Income tax provision / Pre-tax income from continuing operations
d. Income tax provision / Pre-tax income from continuing operations
74. (LO 5) Which of the following items is not a reconciling item in the income tax footnote?
a.
State income taxes
b.
Foreign income taxes
c.
Accrued pension liabilities
d.
Dividends received deduction
e.
Tax exempt municipal bond interest
c. Accrued pension liabilities. Accrued pension liabilities is a temporary difference and
does not appear in the effective tax rate reconciliation unless the company makes an
adjustment to the account that relates to a prior period.
75. (LO 5) Randolph Company reported pre-tax net income from continuing operations of
$800,000 and taxable income of $500,000. The book-tax difference of $300,000 was due to a
$200,000 favorable temporary difference relating to depreciation, an unfavorable temporary
difference of $80,000 due to an increase in the reserve for bad debts, and a $180,000 favorable
permanent difference from the receipt of life insurance proceeds. Randolph Companys
applicable tax rate is 34%.
a.
b.
c.
a.
Compute Randolph Companys current income tax expense.

Compute Randolph Companys deferred income tax expense or benefit.
Compute Randolph Companys effective tax rate.
d.
Provide a reconciliation of Randolph Companys effective tax rate with its
hypothetical tax rate of 34%.
$800,000
(200,000)
80,000
(180,000)
500,000
34%
$170,000
Pre-tax net income

Favorable temporary difference
Unfavorable temporary difference
Favorable permanent difference
Taxable income
34%
Current income tax payable
17-27
b.
Favorable temporary difference

Net favorable temporary difference
34%
Deferred tax expense (liability)
(200,000)
80,000
(120,000)
34%
$(40,800)
Total income tax provision = $170,000 + $40,800 = $210,800

Effective tax rate = $210,800 / $800,000 = 26.35%
c.
d.
ETR reconciliation
Income tax expense at 34% (hypothetical)*
Tax benefit from permanent difference**
Income tax provision
*$800,000 x 34%
**$180,000 x 34%
Hypothetical income tax rate
Tax benefit from permanent difference*
Effective tax rate
*$61,200 / $800,000
$272,000
( 61,200)
$210,800
34.00%
(7.65%)
26.35%
76. (LO 5) Which of the following pronouncements should a company consult in computing its
quarterly income tax provision?
a.
ASC 740
b.
ASC 230
c.
ASC 718
d.
ASC 810
e.
SarbOX 404
a. ASC 740
17-28
Comprehensive Problems
77. You have been assigned to compute the income tax provision for Motown Memories, Inc.
(MM) as of December 31, 2013. The Companys federal income tax rate is 34%. The
Companys Income Statement for 2013 is provided below:
Motown Memories, Inc.
Statement of Operations
at December 31, 2013
Net sales
Cost of sales
Gross profit
$50,000,000
28,000,000
22,000,000
Compensation
Selling expenses
Depreciation and amortization
Other expenses
Total operating expenses
Income from operations
Interest and other income
Income before income taxes
2,000,000
1,500,000
4,000,000
500,000
8,000,000
$14,000,000
1,000,000
$15,000,000
You have identified the following permanent differences:

Interest income from municipal bonds: $50,000
Nondeductible meals and entertainment expenses: $20,000
Domestic production activities deduction: $250,000
Nondeductible fines: $5,000
17-29
MM prepared the following schedule of temporary differences from the beginning of the year to
the end of the year:
Motown Memories, Inc.
Temporary Difference Scheduling Template
BOY
Beginning
Current
EOY
Ending
Taxable (Favorable)
Cumulative
Deferred
Year
Cumulative
Deferred
Temporary Differences
T/D
Taxes (@ 34%)
Change
T/D
Taxes (@ 34%)
Non-current
(8,000,000)
(2,720,000)
(1,000,000)
(9,000,000)
(3,060,000)
BOY
Beginning
Current
EOY
Ending
Deductible (Unfavorable)
Cumulative
Deferred
Year
Cumulative
Deferred
T/D
Taxes (@ 34%)
Change
T/D
Taxes (@ 34%)
Current
200,000
68,000
50,000
250,000
Reserve for warranties
100,000
34,000
20,000
120,000
40,800
Inventory 263A adjustment
240,000
81,600
60,000
300,000
102,000
540,000
183,600
130,000
670,000
227,800
Total current
85,000
Non-Current
Deferred compensation
Total non-current
Total
50,000
17,000
10,000
60,000
20,400
3,000,000
1,020,000
250,000
3,250,000
1,105,000
3,050,000
1,037,000
260,000
3,310,000
1,125,400
3,590,000
1,220,600
390,000
3,980,000
1,353,200
a.
Compute MMs current income tax expense or benefit for 2013.
b.
Compute MMs deferred income tax expense or benefit for 2013.
c.
Prepare a reconciliation of MMs total income tax provision with its hypothetical income
tax expense in both dollars and rates.
See attached spreadsheet solutions.
17-30
78. You have been assigned to compute the income tax provision for Tulip City Flowers, Inc.
(TCF) as of December 31, 2013. The Companys federal income tax rate is 34%. The
Companys Income Statement for 2013 is provided below:
Tulip City Flowers, Inc.
Statement of Operations
at December 31, 2013
Net sales
Cost of sales
Gross profit
$20,000,000
12,000,000
8,000,000
Compensation
Selling expenses
Depreciation and amortization
Other expenses
Total operating expenses
Income from operations
Interest and other income
Income before income taxes
500,000
750,000
1,250,000
1,000,000
3,500,000
$4,500,000
25,000
$4,525,000
You have identified the following permanent differences:

Interest income from municipal bonds: $10,000
Nondeductible stock compensation: $5,000
Domestic production activities deduction: $8,000
Nondeductible fines: $1,000
TCF prepared the following schedule of temporary differences from the beginning of the year to
the end of the year:
17-31

BOY
Beginning
Current
EOY
Ending
Taxable (Favorable)
Cumulative
Deferred
Year
Cumulative
Deferred
T/D
Taxes (@ 34%)
Change
T/D
Taxes (@ 34%)
Non-current
(5,000,000)
(1,700,000)
(500,000)
(5,500,000)
(1,870,000)
BOY
Beginning
Current
EOY
Ending
Cumulative
Deferred
Year
Cumulative
Deferred
T/D
Taxes (@ 34%)
Change
T/D
Taxes (@ 34%)
Current
Prepaid income
Total current
100,000
34,000
10,000
110,000
20,000
20,000
37,400
6,800
100,000
34,000
30,000
130,000
44,200
Non-Current
Total non-current
Total
50,000
17,000
10,000
60,000
20,400
500,000
170,000
100,000
600,000
204,000
550,000
187,000
110,000
660,000
224,400
650,000
221,000
140,000
790,000
268,600
a.
Compute TCFs current income tax expense or benefit for 2013.
b.
Compute TCFs deferred income tax expense or benefit for 2013.
c.
Prepare a reconciliation of TCFs total income tax provision with its hypothetical income
tax expense in both dollars and rates.
d.
Assume TCFs tax rate increased to 35% in 2013. Recompute TCFs deferred income tax
expense or benefit for 2013 using the following template:
17-32

BOY
Beginning
Current
EOY
Ending
Taxable (Favorable)
Cumulative
Deferred
Year
Cumulative
Deferred
T/D
Taxes (@ 34%)
Change
T/D
Taxes (@ 35%)
Non-current
(5,000,000)
(1,700,000)
(500,000)
(5,500,000)
BOY
Beginning
Current
EOY
Ending
Cumulative
Deferred
Year
Cumulative
Deferred
T/D
Taxes (@ 34%)
Change
T/D
Taxes (@ 35%)
Current
Prepaid income
Total current
100,000
34,000
10,000
20,000
110,000
20,000
100,000
34,000
30,000
130,000
Non-Current
Total non-current
Total
50,000
17,000
10,000
60,000
500,000
170,000
100,000
600,000
550,000
187,000
110,000
660,000
650,000
221,000
140,000
790,000
See attached spreadsheet solutions.

79. Access the 2011 Annual Report for Google and answer the following questions. You can
access the annual report at http://www.google.com.
a. Using information from the companys Income Statement and Income Taxes footnote, what
was the companys effective tax rate for 2011? Show how the rate is calculated.
The company reports an effective tax rate of 21% for 2011, computed as $2,589 /
$12,326.
17-33
b. Using information from the Statement of Cash Flows, calculate the companys cash tax rate.
The companys cash tax rate for 2011 was 11.9%, computed as $1,471 / $12,326.
c. What does the companys Income Taxes note tell you about where the company earns its
international income? Why does earning income in these countries cause the effective tax rate to
decrease?
In the Income Taxes note (Note 15), the company informs investors that substantially all
of the income from foreign operations was earned by an Irish subsidiary. Earning
income in Ireland causes the companys effective tax rate to decrease because Ireland
taxes income at a tax rate of 12.5%, which is significantly lower than the U.S. rate of
35%. Under U.S. tax laws, the income earned in these countries is not subject to U.S. tax
until repatriated to the United States. For an interesting discussion of Googles
international operations, see Jesse Drucker, The Tax Haven Thats Saving Google
Billions, Businessweek, October 21, 2010.
d. What item creates the companys largest deferred tax asset? Explain why this item creates a
deductible temporary difference.
The companys largest deferred tax asset relates to Stock-based compensation expense.
The temporary difference results because the company accrues stock-based
compensation under ASC 718 but cannot deduct the expense for tax purposes until the
employees exercise the stock options or earn the right to receive the stock.
e. What item creates the companys largest deferred tax liability? Explain why this item creates a
taxable temporary difference.
Depreciation and amortization. The temporary difference results because the company
depreciates and amortizes its assets for tax purposes using a more accelerated method
than for financial accounting purposes. This creates a taxable temporary difference that
will result in a future tax liability when the book depreciation begins to exceed the tax
depreciation in future periods.
17-34
f. How does the company classify its unrecognized tax benefits on the balance sheet?
The company does not specifically state in its Income Taxes note how it classifies
liabilities for unrecognized tax benefits. However, the company lists non-current Income
Taxes Payable on the balance sheet at $1,693 million, which is close to the $1,564
million of unrecognized tax benefits identified in the Income Taxes note.
g. How does the company treat interest and penalties related to its unrecognized tax benefits?
The company states in its Income Taxes note that it classifies interest and penalties
related to its unrecognized tax benefits as part of its income tax provision.
80. Spartan Builders Corporation is a builder of high end housing with locations in major
metropolitan areas throughout the Midwest. At June 30, 2013, the company has deferred tax
assets totaling $10 million and deferred tax liabilities of $5 million, all of which relate to U.S.
temporary differences. Reversing taxable temporary differences and taxable income in the
carryback period can be used to support approximately $2 million of the $10 million gross
deferred tax asset. The remaining $8 million of gross deferred tax assets will have to come from
future taxable income.
The company has historically been profitable. However, significant loses were incurred in fiscal
years 2011 and 2012. These two years reflect a cumulative loss of 10 million, with losses of $3
million expected in 2013. $7 million of the losses was due to a write-down of inventory.
Beginning in fiscal 2014, management decided to get out of the metropolitan Chicago market,
which had become over-saturated with new houses.
Evaluate the companys need to record a valuation allowance for the $10 million of gross
deferred tax assets . What positive and negative evidence would you weigh?
Positive evidence: The reversing taxable temporary differences and taxable income in
the carryback period is objective information and supports $2 million of deferred tax
assets. In addition, the company has historically been profitable. Subjective positive
evidence is managements decision to leave an unprofitable market and concentrate on
profitable markets.
Negative evidence: The company will have cumulative book loss of $13 million over
three years at the end of 2013. ASC 740 states that cumulative losses is negative
evidence that is difficult to overcome. Even if the write-down of inventory is excluded
from the computation because it is an aberration, there still is a cumulative loss of $6
million over the current and prior two years.
It appears the objective negative evidence outweighs the subjective positive evidence,
and the company should consider recording a valuation allowance for the remaining $8
million of deferred tax assets.
17-35

SMChap 017

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SMChap 017

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Chapter 17 - FASB ASC Topic 740: Income Taxes

U.S. tax laws are complex and ambiguous.

Chapter 17 - FASB ASC Topic 740: Income Taxes

5. (LO 1) What distinguishes an income tax from other taxes?

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Pre-tax book income

Chapter 17 - FASB ASC Topic 740: Income Taxes

Pre-tax book income

NOL carryback to prior year

Pre-tax book income

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Pre-tax book income

NOL carryback to prior year

Reserve for warranties

Accrued pension liability

Goodwill not amortized for tax purposes but

Meal and entertainment expenses

Life insurance proceeds

Net capital loss carryover

Nondeductible fines and penalties

Accrued vacation pay liability paid within the first

Chapter 17 - FASB ASC Topic 740: Income Taxes

Pre-tax book income

Pre-tax book income

Chapter 17 - FASB ASC Topic 740: Income Taxes

More likely than not

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Chapter 17 - FASB ASC Topic 740: Income Taxes

Compute Randolph Companys current income tax expense.

Pre-tax net income

Chapter 17 - FASB ASC Topic 740: Income Taxes

Favorable temporary difference

Total income tax provision = $170,000 + $40,800 = $210,800

Chapter 17 - FASB ASC Topic 740: Income Taxes

You have identified the following permanent differences:

Chapter 17 - FASB ASC Topic 740: Income Taxes

Reserve for warranties

Inventory 263A adjustment

Compute MMs current income tax expense or benefit for 2013.

Compute MMs deferred income tax expense or benefit for 2013.

Chapter 17 - FASB ASC Topic 740: Income Taxes

You have identified the following permanent differences:

Chapter 17 - FASB ASC Topic 740: Income Taxes

Tulip City Flowers, Inc.