Question

During 2018, a company has the following transactions:

i. Sells $30,000 worth of merchandise on credit. The company will collect the accounts in 2019.

ii. Records $3,000 in electricity expense for the month of December. Electricity bills are paid the next month.

iii. Purchases a $12,000 prepaid insurance policy that expires in 2020.

iv. Pays a $1,000 fine for dumping waste materials in a river.

v. Receives $20,000 in magazine subscription proceeds for 12 issues delivered to customers in 2019.

Which of the above transactions will result in a deferred tax asset?

ii and iv

i and iii

iii and iv

ii and v

why is the correct answer is ii and v

Answer 1

Differ tax asset or liability arises when there is timing difference in taxable income and accounting income. When taxable income is more than the accounting income there is a situation for arising deffered tax asset which can be used to adjust against future taxes. In the above question, as per accounting records electricity to be paid will be recorded in books of accounts by following accrual principle how ever tax authorities will allow expenses based on payment bases. Hence it result in deferred tax asset. Similarly for magzine income we may defer as per accounting purposes as the same related to subscriptions to be issued in next year how ever tax authorities will tax the income in the same year . Hence a differed tax asset arises in this situation.

How ever for 1&3 situations accounting and tax treatments are same. Hence no differ tax asset arises.

In case of iv, tax department will not allow the fines and penalities at all hence it is permanent difference and there is no where situation of diferrment arises.