Question

CA19-3 (Identify Temporary Differences and Classification Criteria) The asset-liability approach for recording deferred income taxes is an integral part of generally accepted accounting principles.

Instructions

(a)Indicate whether each of the following independent situations should be treated as a temporary difference or as a permanent difference, and explain why.

(1)Estimated warranty costs (covering a 3-year warranty) are expensed for financial reporting purposes at the time of sale but deducted for income tax purposes when paid.

(2)Depreciation for book and income tax purposes differs because of different bases of carrying the related property, which was acquired in a trade-in. The different bases are a result of different rules used for book and tax purposes to compute the basis of property acquired in a trade-in.

(3)A company properly uses the equity method to account for its 30% investment in another company. The investee pays dividends that are about 10% of its annual earnings.

(4)A company reports a gain on an involuntary conversion of a nonmonetary asset to a monetary asset. The company elects to replace the property within the statutory period using the total proceeds so the gain is not reported on the current year’s tax return.

(b)Discuss the nature of the deferred income tax accounts and the manner in which these accounts are to be reported on the balance sheet.

Answer 1

(1)Estimated warranty costs (covering a 3-year warranty) are expensed for financial reporting purposes at the time of sale but deducted for income tax purposes when paid.	Timing difference since deduction disallowed at the time of sale will be allowed later on when payment is received
(2)Depreciation for book and income tax purposes differs because of different bases of carrying the related property, which was acquired in a trade-in. The different bases are a result of different rules used for book and tax purposes to compute the basis of property acquired in a trade-in.	Timing difference as differentials will be allowed in next period
(3)A company properly uses the equity method to account for its 30% investment in another company. The investee pays dividends that are about 10% of its annual earnings.	Timing difference. However to the extent of deduction for dividend, it will be permanent diff
(4)A company reports a gain on an involuntary conversion of a nonmonetary asset to a monetary asset. The company elects to replace the property within the statutory period using the total proceeds so the gain is not reported on the current year’s tax return.	Timing Difference as gain will be taxed in coming year
(b)Discuss the nature of the deferred income tax accounts and the manner in which these accounts are to be reported on the balance sheet.	Deferred Income tax accounts are reported as asset or liability in balance sheet. If there is timing difference which will be taxed in future years, its liability and if taxed in current year and give benefit in coming years, its asset.