Deferred Income Taxes
Self Test
Intermediate Accounting 2
Self Test
Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.
1. Deferred tax occurs because
a. there is a permanent difference in taxable income and book income
b. there are temporary differences in taxable income and book income
c. some items are never reported on a tax return
d. a company is able to delay paying current year taxes owed
Answer
B. Deferred tax occurs because there is a difference in taxable income/taxes payable and book income/tax expense caused by a difference in when the revenue or expense is recognized for tax purposes. Cumulative cash revenues and expenses will eventually equal cumulative revenues earned and expenses incurred; therefore, these differences are only temporary.
2. A deferred tax asset occurs when
a. there are more tax deductions than book expenses in the current year
b. there are less tax deductions than book expenses in the current year
c. there is more revenue for books than tax in the current year
d. none of the above
Answer
B. A deferred tax asset occurs when more tax is paid than tax expense in the current period. The company paid more tax this period (less tax deductions) and therefore will pay less tax in future periods. Paying less tax in the future is an asset.
3. A deferred tax liability occurs when
a. there are more tax deductions than book expenses in the current year
b. there are less tax deductions than book expenses in the current year
c. there is less revenue for books than tax in the current year
d. none of the above
Answer
A. A deferred tax liability occurs when less tax is paid than tax expense in the current period. The company paid less tax this period (more tax deductions) and therefore will pay more tax in future periods. Paying more tax in the future is an liability.
4. A temporary difference
a. will always reverse in the next year
b. will always net to no difference for all cumulative years
c. is only related to expenses
d. relates to this year’s tax return only
Answer
B. Is a difference that occurs in the current year that will net to no cumulative difference over all years. It may take more than 1 year to net to 0 (a.). A temporary difference can arise from a revenue or an expense treated differently for books than for tax. (c.) The difference will be reported for future years until it eventually nets to 0.
5. A prepaid expense at year end will result in a
a. a deferred tax asset this year and a deferred tax liability next year
b. a deferred tax asset until the prepaid is expensed for books
c. a deferred tax liability until the prepaid is expensed for books
d. no impact to deferred tax accounts
Answer
C. A prepaid expense is cash paid and deducted for tax purposes that has not yet been expensed for books. The company will not have the deduction for tax in the future and will pay more tax in the future which is a deferred tax liability. Once a difference is identified as a liability it remains a liability until the cumulative difference is 0 (it is all expensed for books).
6. Accelerated depreciation methods will result in a
a. a deferred tax asset this year and a deferred tax liability next year
b. a deferred tax liability until the year more depreciation is expensed for books than tax
c. a deferred tax liability until cumulative depreciation expense for books is equal to cumulative depreciation expense for tax.
d. no impact to deferred tax accounts
Answer
C. Accelerated depreciation is greater expense for tax than for books. More deduction is taken for tax than books in the current year and the opposite will occur in the future. Less deduction in the future will cause more taxes to be paid in the future which is a liability. Once the difference is identified as a liability it remains a liability until the book/tax difference is reduced to 0.
7. A temporary difference that records more expense for books than for tax in the current year will result in a
a. deferred tax asset
b. deferred tax liability
c. deferred tax asset for the current year and a deferred tax liability for future years.
d. deferred tax liability for the current year and a deferred tax asset for future years
Answer
A. More expense for books now means less expense for books in the future and more expense for tax in the future. More expense in the future will result in lower taxable income leading to lower taxes paid in the future; a deferred tax asset.
8. The balance in a deferred tax account must always be equal to
a. the current year’s book tax difference multiplied by the current rate
b. the current year’s book tax difference multiplied by the future rate
c. the cumulative book tax difference multiplied by the current tax rate
d. the cumulative book tax difference multiplied by the future tax rate
Answer
D. The balance in the deferred tax account must always be equal to the cumulative book tax difference multiplied by the future tax rate.
9. When recording deferred taxes, the tax payable account and the deferred tax accounts are recorded and tax expense recorded is
a. the amount that makes the journal entry balance
b. always equal to taxable book income multiplied by the current tax rate
c. always equal to taxable income multiplied by the future tax rate
d. equal to cumulative book tax differences multiplied by the future tax rate
Answer
A. According to GAAP, tax expense is the amount that makes the entry balance.
Tax expense is a plug. Tax payable is a computed amount based on taxable income. Deferred tax accounts are recorded for the amount that makes the balance in the deferred tax accounts equal to cumulative book tax differences multiplied by the future tax rate.
10. Deferred taxes are reported on the balances sheet
a. with only one account that nets all deferred tax accounts
b. with always a deferred tax asset and a deferred tax liability
c. as current and non current
d. as only current or non current, but not both
Answer
C. Deferred tax accounts are reported on the balance sheet as current or non current. All liabilities and assets are classified and netted as current or non current. Deferred tax is reported based on when the affect on taxes paid is expected to occur.
11. A deferred tax difference is considered current or non current based on
a. the corresponding book tax difference that causes the deferred tax
b. when the company expects to pay more or less taxes
c. when the deferred tax situation is expected to reverse
d. all of the above
Answer
D. All of the above are considered when determining if a difference is current or non current.
12. A “Net Operating Loss” for tax purposes occurs when the company
a. reports a net loss on their income statement
b. reports a net loss on their tax return
c. incurs more expense than revenues
d. pays more taxes than reported tax expense
Answer
B. A “Net Operating Loss” is a taxable loss reported on the company’s tax return.
13. A NOL carry forward may be carried forward for 20 years and is recorded as a
a. liability
b. receivable
c. deferred tax asset
d. deferred tax liability
Answer
C. A NOL carry forward is used to reduce taxes paid in the future and is a deferred tax asset.
14. A NOL carry back may be carried back 2 years and is recorded as a
a. liability
b. receivable
c. deferred tax asset
d. deferred tax liability
Answer
B. A NOL carry back is a request to the IRS to refund taxes paid in the past two years by netting current year losses against prior year income. It is recorded as a receivable since the IRS will send a cash refund.
15. A deferred tax valuation allowance is required when
a. it is more likely than not that the deferred tax asset will not be realized
b. it is not likely that the deferred tax asset will not be realized
c. it is very likely that the deferred tax asset will be realized
d. there is a deferred tax liability
Answer
A. A deferred tax valuation allowance is required when it is “more likely than not that the deferred tax asset will not be realized”. This occurs when there is doubt that future taxes will be lower, which most often occurs when there is doubt about future income. Valuation allowances are not applicable to deferred tax liabilities.