Question

Ayres Services acquired an asset for $88 million in 2021. The asset is depreciated for financial reporting purposes over four years on a straight-line basis (no residual value). For tax purposes the asset’s cost is depreciated by MACRS. The enacted tax rate is 25%. Amounts for pretax accounting income, depreciation, and taxable income in 2021, 2022, 2023, and 2024 are as follows:

	($ in millions)
	2021				2022				2023				2024
Pretax accounting income	$	335			$	355			$	370			$	405
Depreciation on the income statement		22				22				22				22
Depreciation on the tax return		(50	)			(14	)			(16	)			(8	)
Taxable income	$	307			$	363			$	376			$	419

Required:
For December 31 of each year, determine (a) the cumulative temporary book-tax difference for the depreciable asset and (b) the balance to be reported in the deferred tax liability account.

Answer 1

Part a)

For December 31 of each year, the cumulative temporary book-tax difference for the depreciable asset is determined as below:

Particulars	January 1, 2021	December 31, 2021	December 31, 2022	December 31, 2023	December 31, 2024
Book Value (A)	0	66	44	22	0
Tax Basis (B)	0	38	24	8	0
Cumulative Temporary Difference (A-B)		$28	$20	$14	$0

_____

Notes:

The book value and tax basis for each year is calculated as follows:

Book Value (December 31, 2021) = Cost of Asset - Depreciation on Income Statement for 2021 = 88 - 22 = $66

Tax Basis (December 31, 2021) = Cost of Asset - Depreciation on Tax Return for 2021 = 88 - 50 = $38

_____

Book Value (December 31, 2022) = Book Value (December 31, 2021) - Depreciation on Income Statement for 2022 = 66 - 22 = $44

Tax Basis (December 31, 2022) = Tax Basis (December 31, 2021) - Depreciation on Tax Return for 2022 = 38 - 14 = $24

_____

Book Value (December 31, 2023) = Book Value (December 31, 2022) - Depreciation on Income Statement for 2023 = 44 - 22 = $22

Tax Basis (December 31, 2023) = Tax Basis (December 31, 2022) - Depreciation on Tax Return for 2023 = 24 - 16 = $8

_____

Book Value (December 31, 2024) = Book Value (December 31, 2023) - Depreciation on Income Statement for 2024 = 22 - 22 = $0

Tax Basis (December 31, 2024) = Tax Basis (December 31, 2023) - Depreciation on Tax Return for 2024 = 8 - 8 = $0

_____

Part b)

For December 31 of each year, the balance to be reported in the deferred tax liability account is arrived as below:

Particulars	January 1, 2021	December 31, 2021	December 31, 2022	December 31, 2023	December 31, 2024
Cumulative Temporary Difference (C)	0	28	20	14	0
Tax rate (D)	25%	25%	25%	25%	25%
Deferred Tax Liability (C*D)	$0	$7	$5	$3.5	$0

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Notes:

The value of deferred tax liability is obtained by multiplying the value of cumulative temporary difference for each year with the tax rate.