Question

Your client, a publically-traded company, in 2019 acquires $2.5 million of fixed assets. All of these assets are 5 year class MACRS property. The first three years of MACRS depreciation are: First Year $625,000; Second Year 750,000; Third Year $450,000. For book purposes, the company uses a 10 year useful life, straight-line depreciation with no salvage value. Obviously, these assets will create a DTL. How should the DTL be presented for these assets at the end of year 2? Ignore partial year depreciation and assume a 21% tax rate.
a. $105, 000 Long-Term; $78,750 Short-Term
b. $78,750 Long-Term $105,000 Short-Term
c. $183,750 Long-Term
d. None of the above

Answer 1

Lets first understand the concept of Deferred Tax:-

As per accounting standard, the income tax expenses should be treated just like any other expenses on accrual basis irrespective of the timing of payment of tax. Tax expenses for the period to be recognized consist of current tax and deferred tax.

Current Tax - Current tax is the amount of income tax determined to be payable (recoverable) in respect of the taxable income (tax loss) for a period.

Deferred Tax - Deferred tax is the tax effect of the timing difference. Difference between the tax expenses (which is calculated on accrual basis) and current tax liability to be paid for a particular period as per income tax laws is called deferred tax (assets/liability).   

That is why the Tax Expenses = Current Tax + Deferred Tax

Now Explanation of Deferred Tax Liability (DTL) is provided below:-

DTL is recognized for timing differences that will result in taxable amounts in future years. For example, a timing difference is created between the depreciation as per the books of account and the depreciation claimed under the tax laws which, in initial years, higher than depreciation claimed as expenses in financial statements. This would lead to higher taxable income in future.

	Particulars	Amount
	Year 1
	Depreciation as per Books of Accounts	$ 2,50,000
	Depreciation as per Income Tax Laws (MACRS depreciation)	$ 6,25,000
	Timing Difference that will result in DTL	$ 3,75,000
	Tax Rate	21%
	Deferred Tax Liability (DTL) to be recorded in Books of Accounts in Year 1	$     78,750
	Opening Balance of DTL	$               -
Add:-	DTL to be recognized in books for Year 1	$     78,750
	DTL to be reflected in Balance Sheet for the Year 1	$     78,750
	Year 2
	Depreciation as per Books of Accounts	$ 2,50,000
	Depreciation as per Income Tax Laws (MACRS depreciation)	$ 7,50,000
	Timing Difference that will result in DTL	$ 5,00,000
	Tax Rate	21%
	Deferred Tax Liability (DTL) to be recorded in Books of Accounts in Year 2	$ 1,05,000
	Opening Balance of DTL	$     78,750
Add:-	DTL to be recognized in books for Year 2	$ 1,05,000
	DTL to be reflected in Balance Sheet for the Year 2	$ 1,83,750

So, Answer to the question is (C) :- $183,750 Long-Term.